[Federal Register Volume 81, Number 112 (Friday, June 10, 2016)]
[Proposed Rules]
[Pages 37669-37838]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2016-11788]



[[Page 37669]]

Vol. 81

Friday,

No. 112

June 10, 2016

Part II





 Department of the Treasury





-----------------------------------------------------------------------





Office of the Comptroller of the Currency





-----------------------------------------------------------------------





12 CFR Part 42





Federal Reserve System





-----------------------------------------------------------------------

12 CFR Part 236





Federal Deposit Insurance Corporation





-----------------------------------------------------------------------

12 CFR Part 372





National Credit Union Administration





-----------------------------------------------------------------------

12 CFR Parts 741 and 751





Federal Housing Finance Agency





-----------------------------------------------------------------------

12 CFR Part 1232





Securities and Exchange Commission





-----------------------------------------------------------------------

17 CFR Parts 240, 275, and 303





Incentive-Based Compensation Arrangements; Proposed Rule

Federal Register / Vol. 81 , No. 112 / Friday, June 10, 2016 / 
Proposed Rules

[[Page 37670]]


-----------------------------------------------------------------------

DEPARTMENT OF THE TREASURY

Office of the Comptroller of the Currency

12 CFR Part 42

[Docket No. OCC-2011-0001]
RIN 1557-AD39

FEDERAL RESERVE SYSTEM

12 CFR Part 236

[Docket No. R-1536]
RIN 7100 AE-50

FEDERAL DEPOSIT INSURANCE CORPORATION

12 CFR Part 372

RIN 3064-AD86

NATIONAL CREDIT UNION ADMINISTRATION

12 CFR Parts 741 and 751

RIN 3133-AE48

FEDERAL HOUSING FINANCE AGENCY

12 CFR Part 1232

RIN 2590-AA42

SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 240, 275, and 303

[Release No. 34-77776; IA-4383; File No. S7-07-16]
RIN 3235-AL06


Incentive-Based Compensation Arrangements

AGENCY: Office of the Comptroller of the Currency, Treasury (OCC); 
Board of Governors of the Federal Reserve System (Board); Federal 
Deposit Insurance Corporation (FDIC); Federal Housing Finance Agency 
(FHFA); National Credit Union Administration (NCUA); and U.S. 
Securities and Exchange Commission (SEC).

ACTION: Notice of proposed rulemaking and request for comment.

-----------------------------------------------------------------------

SUMMARY: The OCC, Board, FDIC, FHFA, NCUA, and SEC (the Agencies) are 
seeking comment on a joint proposed rule (the proposed rule) to revise 
the proposed rule the Agencies published in the Federal Register on 
April 14, 2011, and to implement section 956 of the Dodd-Frank Wall 
Street Reform and Consumer Protection Act (Dodd-Frank Act). Section 956 
generally requires that the Agencies jointly issue regulations or 
guidelines: (1) Prohibiting incentive-based payment arrangements that 
the Agencies determine encourage inappropriate risks by certain 
financial institutions by providing excessive compensation or that 
could lead to material financial loss; and (2) requiring those 
financial institutions to disclose information concerning incentive-
based compensation arrangements to the appropriate Federal regulator.

DATES: Comments must be received by July 22, 2016.

ADDRESSES: Although the Agencies will jointly review the comments 
submitted, it would facilitate review of the comments if interested 
parties send comments to the Agency that is the appropriate Federal 
regulator, as defined in section 956(e) of the Dodd-Frank Act, for the 
type of covered institution addressed in the comments. Commenters are 
encouraged to use the title ``Incentive-based Compensation 
Arrangements'' to facilitate the organization and distribution of 
comments among the Agencies. Interested parties are invited to submit 
written comments to:
    Office of the Comptroller of the Currency: Because paper mail in 
the Washington, DC area and at the OCC is subject to delay, commenters 
are encouraged to submit comments by the Federal eRulemaking Portal or 
email, if possible. Please use the title ``Incentive-based Compensation 
Arrangements'' to facilitate the organization and distribution of the 
comments. You may submit comments by any of the following methods:
     Federal eRulemaking Portal--Regulations.gov: Go to 
www.regulations.gov. Enter ``Docket ID OCC-2011-0001'' in the Search 
Box and click ``Search.'' Click on ``Comment Now'' to submit public 
comments.
     Click on the ``Help'' tab on the Regulations.govhome page 
to get information on using Regulations.gov, including instructions for 
submitting public comments.
     Email: [email protected].
     Mail: Legislative and Regulatory Activities Division, 
Office of the Comptroller of the Currency, 400 7th Street SW., Suite 
3E-218, Mail Stop 9W-11, Washington, DC 20219.
     Fax: (571) 465-4326.
     Hand Delivery/Courier: 400 7th Street SW., Suite 3E-218, 
Mail Stop 9W-11, Washington, DC 20219.
    Instructions: You must include ``OCC'' as the agency name and 
``Docket ID OCC-2011-0001'' in your comment. In general, OCC will enter 
all comments received into the docket and publish them on the 
Regulations.gov Web site without change, including any business or 
personal information that you provide such as name and address 
information, email addresses, or phone numbers. Comments received, 
including attachments and other supporting materials, are part of the 
public record and subject to public disclosure. Do not enclose any 
information in your comment or supporting materials that you consider 
confidential or inappropriate for public disclosure.
    You may review comments and other related materials that pertain to 
this proposed rule by any of the following methods:
     Viewing Comments Electronically: Go to 
www.regulations.gov. Enter ``Docket ID OCC-2011-0001'' in the Search 
box and click ``Search.'' Click on ``Open Docket Folder'' on the right 
side of the screen and then ``Comments.'' Comments can be filtered by 
clicking on ``View All'' and then using the filtering tools on the left 
side of the screen.
     Click on the ``Help'' tab on the Regulations.gov home page 
to get information on using Regulations.gov. Supporting materials may 
be viewed by clicking on ``Open Docket Folder'' and then clicking on 
``Supporting Documents.'' The docket may be viewed after the close of 
the comment period in the same manner as during the comment period.
     Viewing Comments Personally: You may personally inspect 
and photocopy comments at the OCC, 400 7th Street SW., Washington, DC. 
For security reasons, the OCC requires that visitors make an 
appointment to inspect comments. You may do so by calling (202) 649-
6700 or, for persons who are deaf or hard of hearing, TTY, (202) 649-
5597. Upon arrival, visitors will be required to present valid 
government-issued photo identification and to submit to security 
screening in order to inspect and photocopy comments.
    Board of Governors of the Federal Reserve System: You may submit 
comments, identified by Docket No. 1536 and RIN No. 7100 AE-50, by any 
of the following methods:
     Agency Web site: http://www.federalreserve.gov. Follow the 
instructions for submitting comments at http://www.federalreserve.gov/generalinfo/foia/ProposedRegs.cfm.
     Federal eRulemaking Portal: http://www.regulations.gov. 
Follow the instructions for submitting comments.
     Email: [email protected]. Include the 
docket number and RIN number in the subject line of the message.

[[Page 37671]]

     Fax: (202) 452-3819 or (202) 452-3102.
     Mail: Address to Robert deV. Frierson, Secretary, Board of 
Governors of the Federal Reserve System, 20th Street and Constitution 
Avenue NW., Washington, DC 20551.
    All public comments will be made available on the Board's Web site 
at http://www.federalreserve.gov/generalinfo/foia/ProposedRegs.cfm as 
submitted, unless modified for technical reasons. Accordingly, comments 
will not be edited to remove any identifying or contact information. 
Public comments may also be viewed electronically or in paper form in 
Room 3515, 1801 K Street NW. (between 18th and 19th Streets NW.), 
Washington, DC 20006 between 9:00 a.m. and 5:00 p.m. on weekdays.
    Federal Deposit Insurance Corporation: You may submit comments, 
identified by RIN 3064-AD86, by any of the following methods:
     Agency Web site: http://www.FDIC.gov/regulations/laws/federal/propose.html. Follow instructions for submitting comments on 
the Agency Web site.
     Email: [email protected]. Include the RIN 3064-AD86 on the 
subject line of the message.
     Mail: Robert E. Feldman, Executive Secretary, Attention: 
Comments, Federal Deposit Insurance Corporation, 550 17th Street NW., 
Washington, DC 20429.
     Hand Delivery: Comments may be hand delivered to the guard 
station at the rear of the 550 17th Street Building (located on F 
Street) on business days between 7:00 a.m. and 5:00 p.m.
     Public Inspection: All comments received, including any 
personal information provided, will be posted generally without change 
to http://www.fdic.gov/regulations/laws/federal.
    Federal Housing Finance Agency: You may submit your written 
comments on the proposed rulemaking, identified by RIN number, by any 
of the following methods:
     Agency Web site: www.fhfa.gov/open-for-comment-or-input.
     Federal eRulemaking Portal: http://www.regulations.gov. 
Follow the instructions for submitting comments. If you submit your 
comment to the Federal eRulemaking Portal, please also send it by email 
to FHFA at [email protected] to ensure timely receipt by the Agency. 
Please include ``RIN 2590-AA42'' in the subject line of the message.
     Hand Delivery/Courier: The hand delivery address is: 
Alfred M. Pollard, General Counsel, Attention: Comments/RIN 2590-AA42, 
Federal Housing Finance Agency, Eighth Floor, 400 7th Street SW., 
Washington, DC 20219. The package should be delivered at the 7th Street 
entrance Guard Desk, First Floor, on business days between 9 a.m. and 5 
p.m.
     U.S. Mail, United Parcel Service, Federal Express, or 
Other Mail Service: The mailing address for comments is: Alfred M. 
Pollard, General Counsel, Attention: Comments/RIN 2590-AA42, Federal 
Housing Finance Agency, 400 7th Street SW., Washington, DC 20219. 
Please note that all mail sent to FHFA via U.S. Mail is routed through 
a national irradiation facility, a process that may delay delivery by 
approximately two weeks.
    All comments received by the deadline will be posted without change 
for public inspection on the FHFA Web site at http://www.fhfa.gov, and 
will include any personal information provided, such as name, address 
(mailing and email), and telephone numbers. Copies of all comments 
timely received will be available for public inspection and copying at 
the address above on government-business days between the hours of 
10:00 a.m. and 3:00 p.m. To make an appointment to inspect comments 
please call the Office of General Counsel at (202) 649-3804.
    National Credit Union Administration: You may submit comments by 
any of the following methods (please send comments by one method only):
     Federal eRulemaking Portal: http://www.regulations.gov. 
Follow the instructions for submitting comments.
     Agency Web site: http://www.ncua.gov. Follow the 
instructions for submitting comments.
     Email: Address to [email protected]. Include ``[Your 
name] Comments on ``Notice of Proposed Rulemaking for Incentive-based 
Compensation Arrangements'' in the email subject line.
     Fax: (703) 518-6319. Use the subject line described above 
for email.
     Mail: Address to Gerard S. Poliquin, Secretary of the 
Board, National Credit Union Administration, 1775 Duke Street, 
Alexandria, Virginia 22314-3428.
     Hand Delivery/Courier: Same as mail address.
     Public Inspection: All public comments are available on 
the agency's Web site at http://www.ncua.gov/Legal/Regs/Pages/PropRegs.aspx as submitted, except when not possible for technical 
reasons. Public comments will not be edited to remove any identifying 
or contact information. Paper copies of comments may be inspected in 
NCUA's law library at 1775 Duke Street, Alexandria, Virginia 22314, by 
appointment weekdays between 9:00 a.m. and 3:00 p.m. To make an 
appointment, call (703) 518-6546 or send an email to [email protected].
    Securities and Exchange Commission: You may submit comments by the 
following method:

Electronic Comments

     Use the SEC's Internet comment form (http://www.sec.gov/rules/proposed.shtml);
     Send an email to [email protected]. Please include 
File Number S7-07-16 on the subject line; or
     Use the Federal eRulemaking Portal (http://www.regulations.gov). Follow the instructions for submitting comments.

Paper Comments

     Send paper comments in triplicate to Brent J. Fields, 
Secretary, Securities and Exchange Commission, 100 F Street NE., 
Washington, DC 20549.

All submissions should refer to File Number S7-07-16. This file number 
should be included on the subject line if email is used. To help us 
process and review your comments more efficiently, please use only one 
method. The SEC will post all comments on the SEC's Internet Web site 
(http://www.sec.gov/rules/proposed.shtml). Comments are also available 
for Web site viewing and printing in the SEC's Public Reference Room, 
100 F Street NE., Washington, DC 20549 on official business days 
between the hours of 10:00 a.m. and 3:00 p.m. All comments received 
will be posted without change; the SEC does not edit personal 
identifying information from submissions. You should submit only 
information that you wish to make available publicly.
    Studies, memoranda or other substantive items may be added by the 
SEC or staff to the comment file during this rulemaking. A notification 
of the inclusion in the comment file of any such materials will be made 
available on the SEC's Web site. To ensure direct electronic receipt of 
such notifications, sign up through the ``Stay Connected'' option at 
www.sec.gov to receive notifications by email.

FOR FURTHER INFORMATION CONTACT: 
    OCC: Patrick T. Tierney, Assistant Director, Alison MacDonald, 
Senior Attorney, and Melissa Lisenbee, Attorney, Legislative and 
Regulatory Activities, (202) 649-5490, and Judi McCormick, Analyst, 
Operational Risk Policy, (202) 649-6415, Office of the Comptroller of 
the Currency, 400 7th Street SW., Washington, DC 20219.
    Board: Teresa Scott, Manager, (202) 973-6114, Meg Donovan, Senior 
Supervisory Financial Analyst, (202)

[[Page 37672]]

872-7542, or Joe Maldonado, Supervisory Financial Analyst, (202) 973-
7341, Division of Banking Supervision and Regulation; or Laurie 
Schaffer, Associate General Counsel, (202) 452-2272, Michael Waldron, 
Special Counsel, (202) 452-2798, Gillian Burgess, Counsel, (202) 736-
5564, Flora Ahn, Counsel, (202) 452-2317, or Steve Bowne, Senior 
Attorney, (202) 452-3900, Legal Division, Board of Governors of the 
Federal Reserve System, 20th and C Streets NW., Washington, DC 20551.
    FDIC: Rae-Ann Miller, Associate Director, Risk Management Policy, 
Division of Risk Management Supervision (202) 898-3898, Catherine 
Topping, Counsel, Legal Division, (202) 898-3975, and Nefretete Smith, 
Counsel, Legal Division, (202) 898-6851.
    FHFA: Mary Pat Fox, Manager, Executive Compensation Branch, (202) 
649-3215; or Lindsay Simmons, Assistant General Counsel, (202) 649-
3066, Federal Housing Finance Agency, 400 7th Street SW., Washington, 
DC 20219. The telephone number for the Telecommunications Device for 
the Hearing Impaired is (800) 877-8339.
    NCUA: Vickie Apperson, Program Officer, and Jeffrey Marshall, 
Program Officer, Office of Examination & Insurance, (703) 518-6360; or 
Elizabeth Wirick, Senior Staff Attorney, Office of General Counsel, 
(703) 518-6540, National Credit Union Administration, 1775 Duke Street, 
Alexandria, Virginia 22314.
    SEC: Raymond A. Lombardo, Branch Chief, Kevin D. Schopp, Special 
Counsel, Division of Trading & Markets, (202) 551-5777 or 
[email protected]; Sirimal R. Mukerjee, Senior Counsel, Melissa 
R. Harke, Branch Chief, Division of Investment Management, (202) 551-
6787 or [email protected], U.S. Securities and Exchange Commission, 100 F 
Street NE., Washington, DC 20549.

SUPPLEMENTARY INFORMATION: 

Table of Contents

I. Introduction
    A. Background
    B. Supervisory Experience
    C. Overview of the 2011 Proposed Rule and Public Comment
    D. International Developments
    E. Overview of the Proposed Rule
II. Section-by-Section Description of the Proposed Rule
    Sec.  __.1 Authority, Scope and Initial Applicability
    Sec.  __.2 Definitions
    Definitions Pertaining to Covered Institutions
    Consolidation
    Level 1, Level 2, and Level 3 Covered Institutions
    Definitions Pertaining to Covered Persons
    Relative Compensation Test
    Exposure Test
    Exposure Test at Certain Affiliates
    Dollar Threshold Test
    Other Definitions
    Relationship Between Defined Terms
    Sec.  __.3 Applicability
    (a) When Average Total Consolidated Assets Increase
    (b) When Total Consolidated Assets Decrease
    (c) Compliance of Covered Institutions That Are Subsidiaries of 
Covered Institutions
    Sec.  __.4 Requirements and Prohibitions Applicable to All 
Covered Institutions
    (a) In General
    (b) Excessive Compensation
    (c) Material Financial Loss
    (d) Performance Measures
    (e) Board of Directors
    (f) Disclosure and Recordkeeping Requirements and (g) Rule of 
Construction
    Sec.  __.5 Additional Disclosure and Recordkeeping Requirements 
for Level 1 and Level 2 Covered Institutions
    Sec.  __.6 Reservation of Authority for Level 3 Covered 
Institutions
    Sec.  __.7 Deferral, Forfeiture and Downward Adjustment, and 
Clawback Requirements for Level 1 and Level 2 Covered Institutions
    Sec.  __.7(a) Deferral
    Sec.  __.7(a)(1) and Sec.  __.7(a)(2) Minimum Deferral Amounts 
and Deferral Periods for Qualifying Incentive-Based Compensation and 
Incentive-Based Compensation Awarded Under a Long-Term Incentive 
Plan
    Pro Rata Vesting
    Acceleration of Payments
    Qualifying Incentive-Based Compensation and Incentive-Based 
Compensation Awarded Under a Long-Term Incentive Plan
    Sec.  __.7(a)(3) Adjustments of Deferred Qualifying Incentive-
Based Compensation and Deferred Long-Term Incentive Plan 
Compensation Amounts
    Sec.  __.7(a)(4) Composition of Deferred Qualifying Incentive-
Based Compensation and Deferred Long-Term Incentive Plan 
Compensation for Level 1 and Level 2 Covered Institutions
    Cash and Equity-Like Instruments
    Options
    Sec.  __.7(b) Forfeiture and Downward Adjustment
    Sec.  __.7(b)(1) Compensation at Risk
    Sec.  __.7(b)(2) Events Triggering Forfeiture and Downward 
Adjustment Review
    Sec.  __.7(b)(3) Senior Executive Officers and Significant Risk-
Takers Affected by Forfeiture and Downward Adjustment
    Sec.  __.7(b)(4) Determining Forfeiture and Downward Adjustment 
Amounts
    Sec.  __.7(c) Clawback
    Sec.  __.8 Additional Prohibitions for Level 1 and Level 2 
Covered Institutions
    Sec.  __.8(a) Hedging
    Sec.  __.8(b) Maximum Incentive-Based Compensation Opportunity
    Sec.  __.8(c) Relative Performance Measures
    Sec.  __.8(d) Volume-Driven Incentive-Based Compensation
    Sec.  __.9 Risk Management and Controls Requirements for Level 1 
and Level 2 Covered Institutions
    Sec.  __.10 Governance Requirements for Level 1 and Level 2 
Covered Institutions
    Sec.  __.11 Policies and Procedures Requirements for Level 1 and 
Level 2 Covered Institutions
    Sec.  __.12 Indirect Actions
    Sec.  __.13 Enforcement
    Sec.  __.14 NCUA and FHFA Covered Institutions in 
Conservatorship, Receivership, or Liquidation
    SEC Amendment to Exchange Act Rule 17a-4
    SEC Amendment to Investment Advisers Act Rule 204-2
III. Appendix to the Supplementary Information: Example Incentive-
Based Compensation Arrangement and Forfeiture and Downward 
Adjustment Review
    Ms. Ledger: Senior Executive Officer at Level 2 Covered 
Institution Balance
    Award of Incentive-Based Compensation for Performance Periods 
Ending December 31, 2024
    Vesting Schedule
    Use of Options in Deferred Incentive-Based Compensation
    Other Requirements Specific to Ms. Ledger's Incentive-Based 
Compensation Arrangement
    Risk Management and Controls and Governance
    Recordkeeping
    Mr. Ticker: Forfeiture and Downward Adjustment Review
IV. Request for Comments
V. Regulatory Analysis
    A. Regulatory Flexibility Act
    B. Paperwork Reduction Act
    C. The Treasury and General Government Appropriations Act, 
1999--Assessment of Federal Regulations and Policies on Families
    D. Riegle Community Development and Regulatory Improvement Act 
of 1994
    E. Solicitation of Comments on Use of Plain Language
    F. OCC Unfunded Mandates Reform Act of 1995 Determination
    G. Differences Between the Federal Home Loan Banks and the 
Enterprises
    H. NCUA Executive Order 13132 Determination
    I. SEC Economic Analysis
    J. Small Business Regulatory Enforcement Fairness Act
    List of Subjects

I. Introduction

    Section 956 of the Dodd-Frank Wall Street Reform and Consumer 
Protection Act (the ``Dodd-Frank Act'' or the ``Act'') \1\ requires the 
Agencies to jointly prescribe regulations or guidelines with respect to 
incentive-based compensation practices at certain financial 
institutions (referred to as ``covered financial

[[Page 37673]]

institutions'').\2\ Specifically, section 956 of the Dodd-Frank Act 
(``section 956'') requires that the Agencies prohibit any types of 
incentive-based compensation \3\ arrangements, or any feature of any 
such arrangements, that the Agencies determine encourage inappropriate 
risks by a covered financial institution: (1) By providing an executive 
officer, employee, director, or principal shareholder of the covered 
financial institution with excessive compensation, fees, or benefits; 
or (2) that could lead to material financial loss to the covered 
financial institution. Under the Act, a covered financial institution 
also must disclose to its appropriate Federal regulator the structure 
of its incentive-based compensation arrangements sufficient to 
determine whether the structure provides excessive compensation, fees, 
or benefits or could lead to material financial loss to the 
institution. The Dodd-Frank Act does not require a covered financial 
institution to report the actual compensation of particular 
individuals.
---------------------------------------------------------------------------

    \1\ Public Law 111-203, 124 Stat. 1376 (2010).
    \2\ 12 U.S.C. 5641.
    \3\ Section 956(b) uses the term ``incentive-based payment 
arrangement.'' It appears that Congress used the terms ``incentive-
based payment arrangement'' and ``incentive-based compensation 
arrangement'' interchangeably. The Agencies have chosen to use the 
term ``incentive-based compensation arrangement'' throughout the 
proposed rule and this SUPPLEMENTARY INFORMATION section for the 
sake of clarity.
---------------------------------------------------------------------------

    The Act defines ``covered financial institution'' to include any of 
the following types of institutions that have $1 billion or more in 
assets: (A) A depository institution or depository institution holding 
company, as such terms are defined in section 3 of the Federal Deposit 
Insurance Act (``FDIA'') (12 U.S.C. 1813); (B) a broker-dealer 
registered under section 15 of the Securities Exchange Act of 1934 (15 
U.S.C. 78o); (C) a credit union, as described in section 
19(b)(1)(A)(iv) of the Federal Reserve Act; (D) an investment adviser, 
as such term is defined in section 202(a)(11) of the Investment 
Advisers Act of 1940 (15 U.S.C. 80b-2(a)(11)); (E) the Federal National 
Mortgage Association (Fannie Mae); (F) the Federal Home Loan Mortgage 
Corporation (Freddie Mac); and (G) any other financial institution that 
the appropriate Federal regulators, jointly, by rule, determine should 
be treated as a covered financial institution for these purposes.
    The Act also requires that any compensation standards adopted under 
section 956 be comparable to the safety and soundness standards 
applicable to insured depository institutions under section 39 of the 
FDIA \4\ and that the Agencies take the compensation standards 
described in section 39 of the FDIA into consideration in establishing 
compensation standards under section 956.\5\ As explained in greater 
detail below, the standards established by the proposed rule are 
comparable to the standards established under section 39 of the FDIA.
---------------------------------------------------------------------------

    \4\ 12 U.S.C. 1831p-1. The OCC, Board, and FDIC (collectively, 
the ``Federal Banking Agencies'') each have adopted guidelines 
implementing the compensation-related and other safety and soundness 
standards in section 39 of the FDIA. See Interagency Guidelines 
Establishing Standards for Safety and Soundness (the ``Federal 
Banking Agency Safety and Soundness Guidelines''), 12 CFR part 30, 
Appendix A (OCC); 12 CFR part 208, Appendix D-1 (Board); 12 CFR part 
364, Appendix A (FDIC).
    \5\ 12 U.S.C. 1831p-1(c).
---------------------------------------------------------------------------

    In April 2011, the Agencies published a joint notice of proposed 
rulemaking that proposed to implement section 956 (2011 Proposed 
Rule).\6\ Since the 2011 Proposed Rule was published, incentive-based 
compensation practices have evolved in the financial services industry. 
The Board, the OCC, and the FDIC have gained experience in applying 
guidance on incentive-based compensation,\7\ FHFA has gained 
supervisory experience in applying compensation-related rules \8\ 
adopted under the authority of the Safety and Soundness Act,\9\ and 
foreign jurisdictions have adopted incentive-based compensation 
remuneration codes, regulations, and guidance.\10\ In light of these 
developments and the comments received on the 2011 Proposed Rule, the 
Agencies are publishing a new proposed rule to implement section 956.
---------------------------------------------------------------------------

    \6\ 76 FR 21170 (April 14, 2011).
    \7\ OCC, Board, FDIC, and Office of Thrift Supervision, 
``Guidance on Sound Incentive Compensation Policies'' (``2010 
Federal Banking Agency Guidance''), 75 FR 36395 (June 25, 2010).
    \8\ These include the Executive Compensation Rule (12 CFR part 
1230), the Golden Parachute Payments Rule (12 CFR part 1231), and 
the Federal Home Loan Bank Directors' Compensation and Expenses Rule 
(12 CFR part 1261 subpart C).
    \9\ The Safety and Soundness Act means the Federal Housing 
Enterprises Financial Safety and Soundness Act of 1992, as amended 
(12 U.S.C. 4501 et seq.). 12 CFR 1201.1.
    \10\ See, e.g., the European Union, Directive 2013/36/EU 
(effective January 1, 2014); United Kingdom Prudential Regulation 
Authority (``PRA'') and Financial Conduct Authority (``FCA''), ``PRA 
PS12/15/FCA PS15/16: Strengthening the Alignment of Risk and Reward: 
New Remuneration Rules'' (June 25, 2015) (``UK Remuneration 
Rules''), available at http://www.bankofengland.co.uk/pra/Documents/publications/ps/2015/ps1215.pdf; Australian Prudential Regulation 
Authority (``APRA''), Prudential Practice Guide SPG 511--
Remuneration (November 2013), available at http://www.apra.gov.au/Super/Documents/Prudential-Practice-Guide-SPG-511-Remuneration.pdf; 
Canada, The Office of the Superintendent of Financial Institutions 
(``OSFI'') Corporate Governance Guidelines (January 2013) (``OSFI 
Corporate Governance Guidelines''), available at http://www.osfi-bsif.gc.ca/eng/fi-if/rg-ro/gdn-ort/gl-ld/pages/cg_guideline.aspx and 
Supervisory Framework (December 2010) (``OSFI Supervisory 
Framework''), available at http://www.osfi-bsif.gc.ca/Eng/Docs/sframew.pdf; Switzerland, Financial Market Supervisory Authority 
(``FINMA''), 2010/01 FINMA Circular on Remuneration Schemes (October 
2009) (``FINMA Remuneration Circular''), available at https://www.finma.ch/en/documentation/circulars/#Order=2.
---------------------------------------------------------------------------

    The first part of this SUPPLEMENTARY INFORMATION section provides 
background information on the proposed rule, including a summary of the 
2011 Proposed Rule and areas in which the proposed rule differs from 
the 2011 Proposed Rule. The second part contains a section-by-section 
description of the proposed rule.\11\ To help explain how the 
requirements of the proposed rule would work in practice, the Appendix 
to this SUPPLEMENTARY INFORMATION section sets out an example of an 
incentive-based compensation arrangement for a hypothetical senior 
executive officer at a hypothetical large banking organization and an 
example of how a forfeiture and downward adjustment review might be 
conducted for a senior manager at a hypothetical large banking 
organization.
---------------------------------------------------------------------------

    \11\ This section-by-section description also includes certain 
examples of how the proposed rule would work in practice. These 
examples are intended solely for purposes of illustration and do not 
cover every aspect of the proposed rule. They are provided as an aid 
to understanding the proposed rule and do not carry the force and 
effect of law or regulation.
---------------------------------------------------------------------------

    For ease of reference, the proposed rules of the Agencies are 
referenced in this Supplementary Information section using a common 
designation of section __.1 to section __.14 (excluding the title and 
part designations for each agency). Each agency would codify its rule, 
if adopted, within its respective title of the Code of Federal 
Regulations.\12\
---------------------------------------------------------------------------

    \12\ Specifically, the Agencies propose to codify the rules as 
follows: 12 CFR part 42 (OCC); 12 CFR part 236 (the Board); 12 CFR 
part 372 (FDIC); 17 CFR part 303 (SEC); 12 CFR parts 741 and 751 
(NCUA); and 12 CFR part 1232 (FHFA).
---------------------------------------------------------------------------

A. Background

    Incentive-based compensation arrangements are critical tools in the 
management of financial institutions. These arrangements serve several 
important objectives, including attracting and retaining skilled staff 
and promoting better performance of the institution and individual 
employees. Well-structured incentive-based compensation arrangements 
can promote the health of a financial institution by aligning the 
interests of executives and employees with those of

[[Page 37674]]

the institution's shareholders and other stakeholders. At the same 
time, poorly structured incentive-based compensation arrangements can 
provide executives and employees with incentives to take inappropriate 
risks that are not consistent with the long-term health of the 
institution and, in turn, the long-term health of the U.S. economy. 
Larger financial institutions in particular are interconnected with one 
another and with many other companies and markets, which can mean that 
any negative impact from inappropriate risk-taking can have broader 
consequences. The risk of these negative externalities may not be fully 
taken into account in incentive-based compensation arrangements, even 
arrangements that otherwise align the interests of shareholders and 
other stakeholders with those of executives and employees.
    There is evidence that flawed incentive-based compensation 
practices in the financial industry were one of many factors 
contributing to the financial crisis that began in 2007. Some 
compensation arrangements 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.\13\ Traders with large position limits, 
underwriters, and loan officers are three examples of non-executive 
personnel who had the ability to expose an institution to material 
amounts of risk. Significant losses caused by actions of individual 
traders or trading groups occurred at some of the largest financial 
institutions during and after the financial crisis.\14\
---------------------------------------------------------------------------

    \13\ See, e.g., Financial Crisis Inquiry Commission, ``Financial 
Crisis Inquiry Report'' (January 2011), at 209, 279, 291, 343, 
available at https://www.gpo.gov/fdsys/pkg/GPO-FCIC/pdf/GPO-FCIC.pdf; Senior Supervisors Group, ``Observations on Risk 
Management Practices during the Recent Market Turbulence'' (March 6, 
2008), available at https://www.newyorkfed.org/medialibrary/media/newsevents/news/banking/2008/SSG_Risk_Mgt_doc_final.pdf.
    \14\ A large financial institution suffered losses in 2012 from 
trading by an investment office in its synthetic credit portfolio. 
These losses amounted to approximately $5.8 billion, which was 
approximately 3.6 percent of the holding company's tier 1 capital. 
https://www.sec.gov/Archives/edgar/data/19617/000001961713000221/0000019617-13-000221-index.htm Form 10-K 2013, Pages 69 and 118. In 
2007, a proprietary trading group at another large institution 
caused losses of an estimated $7.8 billion (approximately 25 percent 
of the firm's total stockholder's equity). http://www.morganstanley.com/about-us-ir/shareholder/10k113008/10k1108.pdf 
Form 10-K 2008, Pages 45 and 108. Between 2005 and 2008, one futures 
trader at a large financial institution engaged in activities that 
caused losses of an estimated EUR4.9 billion in 2007, which was 
approximately 23 percent of the firm's 2007 tier 1 capital. http://www.societegenerale.com/sites/default/files/03%20March%202008%202008%20Registration%20Document.pdf, Pages, 52, 
159-160; http://www.societegenerale.com/sites/default/files/12%20May%202008%20The%20report%20by%20the%20General%20Inspection%20of%20Societe%20Generale.pdf, Pages 1-71. In 2011, one trader at 
another large financial institution caused losses of an estimated 
$2.25 billion, which represented approximately 5.4 percent of the 
firm's tier 1 capital. https://www.fca.org.uk/news/press-releases/fca-bans-kweku-mawuli-adoboli-from-the-financial-services-industry, 
Page 1; https://www.ubs.com/global/en/about_ubs/investor_relations/other_filings/sec.html. 2012 SEC Form 20-F, Page 34. In 2007, one 
trader caused losses of an estimated $264 million at a large 
financial institution, which represented approximately 1.7 percent 
of its tier 1 capital. http://www.federalreserve.gov/newsevents/press/enforcement/20081118a.htm, Page 1; https://www.bmo.com/ci/ar2008/downloads/bmo_ar2008.pdf, Page 61.
---------------------------------------------------------------------------

    Of particular note were incentive-based compensation arrangements 
for employees in a position to expose the institution to substantial 
risk that failed to align the employees' interests with those of the 
institution. For example, some institutions gave loan officers 
incentives to write a large amount of loans or gave traders incentives 
to generate high levels of trading revenues, without sufficient regard 
for the risks associated with those activities. The revenues that 
served as the basis for calculating bonuses were generated immediately, 
while the risk outcomes might not have been realized for months or 
years after the transactions were completed. When these, or similarly 
misaligned incentive-based compensation arrangements, are common in an 
institution, the foundation of sound risk management can be undermined 
by the actions of employees seeking to maximize their own compensation.
    The effect of flawed incentive-based compensation practices is 
demonstrated by the arrangements implemented by Washington Mutual 
(WaMu). According to the Senate Permanent Subcommittee on 
Investigations Staff's report on the failure of WaMu ``[l]oan officers 
and processors were paid primarily on volume, not primarily on the 
quality of their loans, and were paid more for issuing higher risk 
loans. Loan officers and mortgage brokers were also paid more when they 
got borrowers to pay higher interest rates, even if the borrower 
qualified for a lower rate--a practice that enriched WaMu in the short 
term, but made defaults more likely down the road.'' \15\
---------------------------------------------------------------------------

    \15\ Staff of S. Permanent Subcomm. on Investigations, Wall 
Street and the Financial Crisis: Anatomy of a Financial Collapse at 
143 (Comm. Print 2011).
---------------------------------------------------------------------------

    Flawed incentive-based compensation arrangements were evident in 
not just U.S. financial institutions, but also major financial 
institutions worldwide.\16\ In a 2009 survey of banking organizations 
engaged in wholesale banking activities, the Institute of International 
Finance found that 98 percent of respondents recognized the 
contribution of incentive-based compensation practices to the financial 
crisis.\17\
---------------------------------------------------------------------------

    \16\ See Financial Stability Forum, ``FSF Principles for Sound 
Compensation Practices'' (April 2009) (the ``FSB Principles''), 
available at http://www.financialstabilityboard.org/publications/r_0904b.pdf; Senior Supervisors Group, ``Risk-management Lessons 
from the Global Banking Crisis of 2008'' (October 2009), available 
at http://www.newyorkfed.org/newsevents/news/banking/2009/ma091021.html. The Financial Stability Forum was renamed the 
Financial Stability Board (``FSB'') in April 2009.
    \17\ See Institute of International Finance, Inc., 
``Compensation in Financial Services: Industry Progress and the 
Agenda for Change'' (March 2009), available at http://www.oliverwyman.com/ow/pdf_files/OW_En_FS_Publ_2009_CompensationInFS.pdf. See also UBS, ``Shareholder 
Report on UBS's Write-Downs,'' (April 18, 2008), at 41-42 
(identifying incentive effects of UBS compensation practices as 
contributing factors in losses suffered by UBS due to exposure to 
the subprime mortgage market), available at http://www.ubs.com/1/ShowMedia/investors/agm?contentId=140333&name=080418ShareholderReport.pdf.
---------------------------------------------------------------------------

    Shareholders and other stakeholders in a covered institution \18\ 
have an interest in aligning the interests of executives, managers, and 
other employees with the institution's long-term health. However, 
aligning the interests of shareholders (or members, in the case of 
credit unions, mutual savings associations, mutual savings banks, some 
mutual holding companies, and Federal Home Loan Banks) and other 
stakeholders with employees may not always be sufficient to protect the 
safety and soundness of an institution, deter excessive compensation, 
or deter behavior or inappropriate risk-taking that could lead to 
material financial loss at the institution. Executive officers and 
employees of a covered institution may be willing to tolerate a degree 
of risk that is inconsistent with the interests of stakeholders, as 
well as broader public policy goals.
---------------------------------------------------------------------------

    \18\ As discussed below, the proposed rule uses the term 
``covered institution'' rather than the statutory term ``covered 
financial institution.''
---------------------------------------------------------------------------

    Generally, the incentive-based compensation arrangements of a 
covered institution should reflect the interests of the shareholders 
and other stakeholders, to the extent that the incentive-based 
compensation makes those covered persons demand more or less reward for 
their risk-taking at the covered institution, and to the extent that 
incentive-based compensation

[[Page 37675]]

changes those covered persons' risk-taking. However, risks undertaken 
by a covered institution--particularly a larger institution--can spill 
over into the broader economy, affecting other institutions and 
stakeholders. Therefore, there may be reasons why the preferences of 
all of the stakeholders are not fully reflected in incentive-based 
compensation arrangements. Hence, there is a public interest in 
curtailing the inappropriate risk-taking incentives provided by 
incentive-based compensation arrangements. Without restrictions on 
incentive-based compensation arrangements, covered institutions may 
engage in more risk-taking than is optimal from a societal perspective, 
suggesting that regulatory measures may be required to cut back on the 
risk-taking incentivized by such arrangements. Particularly at larger 
institutions, shareholders and other stakeholders may have difficulty 
effectively monitoring and controlling the impact of incentive-based 
compensation arrangements throughout the institution that may affect 
the institution's risk profile, the full range of stakeholders, and the 
larger economy.
    As a result, supervision and regulation of incentive-based 
compensation can play an important role in helping safeguard covered 
institutions against incentive-based compensation practices that 
threaten safety and soundness, are excessive, or could lead to material 
financial loss. In particular, such supervision and regulation can help 
address the negative externalities affecting the broader economy or 
other institutions that may arise from inappropriate risk-taking by 
large financial institutions.

B. Supervisory Experience

    To address such practices, the Federal Banking Agencies proposed, 
and then later adopted, the 2010 Federal Banking Agency Guidance 
governing incentive-based compensation programs, which applies to all 
banking organizations regardless of asset size. This Guidance uses a 
principles-based approach to ensure that incentive-based compensation 
arrangements appropriately tie rewards to longer-term performance and 
do not undermine the safety and soundness of banking organizations or 
create undue risks to the financial system. In addition, to foster 
implementation of improved incentive-based compensation practices, the 
Board, in cooperation with the OCC and FDIC, initiated in late 2009 a 
multidisciplinary, horizontal review (``Horizontal Review'') of 
incentive-based compensation practices at 25 large, complex banking 
organizations, which is still ongoing.\19\ One goal of the Horizontal 
Review is to help improve the Federal Banking Agencies' understanding 
of the range and evolution of incentive-based compensation practices 
across institutions and categories of employees within institutions. 
The second goal is to provide guidance to each institution in 
implementing the 2010 Federal Banking Agency Guidance. The supervisory 
experience of the Federal Banking Agencies in this area is also 
relevant to the incentive-based compensation practices at broker-
dealers and investment advisers.
---------------------------------------------------------------------------

    \19\ The financial institutions in the Horizontal Review are 
Ally Financial Inc.; American Express Company; Bank of America 
Corporation; The Bank of New York Mellon Corporation; Capital One 
Financial Corporation; Citigroup Inc.; Discover Financial Services; 
The Goldman Sachs Group, Inc.; JPMorgan Chase & Co.; Morgan Stanley; 
Northern Trust Corporation; The PNC Financial Services Group, Inc.; 
State Street Corporation; SunTrust Banks, Inc.; U.S. Bancorp; and 
Wells Fargo & Company; and the U.S. operations of Barclays plc, BNP 
Paribas, Credit Suisse Group AG, Deutsche Bank AG, HSBC Holdings 
plc, Royal Bank of Canada, The Royal Bank of Scotland Group plc, 
Societe Generale, and UBS AG.
---------------------------------------------------------------------------

    As part of the Horizontal Review, the Board conducted reviews of 
line of business operations in the areas of trading, mortgage, credit 
card, and commercial lending operations as well as senior executive 
incentive-based compensation awards and payouts. The institutions 
subject to the Horizontal Review have made progress in developing 
practices that would incorporate the principles of the 2010 Federal 
Banking Agency Guidance into their risk management systems, including 
through better recognition of risk in incentive-based compensation 
decision-making and improved practices to better balance risk and 
reward. Many of those changes became evident in the actual compensation 
arrangements of the institutions as the review progressed. In 2011, the 
Board made public its initial findings from the Horizontal Review, 
recognizing the steps the institutions had made towards improving their 
incentive-based compensation practices, but also noting that each 
institution needed to do more.\20\ In early 2012, the Board initiated a 
second, cross-firm review of 12 additional large banking organizations 
(``2012 LBO Review''). The Board also monitors incentive-based 
compensation as part of ongoing supervision. Supervisory oversight 
focuses most intensively on large banking organizations because they 
are significant users of incentive-based compensation and because 
flawed approaches at these organizations are more likely to have 
adverse effects on the broader financial system. As part of that 
supervision, the Board also conducts targeted incentive-based 
compensation exams and considers incentive-based compensation in the 
course of wider line of business and risk-related reviews.
---------------------------------------------------------------------------

    \20\ Board, ``Incentive Compensation Practices: A Report on the 
Horizontal Review of Practices at Large Banking Organizations'' 
(October 2011) (``2011 FRB White Paper), available at http://www.federalreserve.gov/publications/other-reports/files/incentive-compensation-practices-report-201110.pdf.
---------------------------------------------------------------------------

    For the past several years, the Board also has been actively 
engaged in international compensation, governance, and conduct working 
groups that have produced a variety of publications aimed at further 
improving incentive-based compensation practices.\21\
---------------------------------------------------------------------------

    \21\ See, e.g., FSB Principles; FSB, ``FSB Principles for Sound 
Compensation Practices: Implementation Standards, Basel, 
Switzerland'' (September 2009), available at http://www.fsb.org/wp-content/uploads/r_090925c.pdf?page_moved=1 (together with the FSB 
Principles, the ``FSB Principles and Implementation Standards''); 
Basel Committee on Banking Supervision, ``Report on Range of 
Methodologies for Risk and Performance Alignment of Remuneration'' 
(May 2011); Basel Committee on Banking Supervision, ``Principles for 
the Effective Supervision of Financial Conglomerates'' (September 
2012); FSB, ``Implementing the FSB Principles for Sound Compensation 
Practices and their Implementation Standards--First, Second, Third, 
and Fourth Progress Reports'' (June 2012, August 2013, November 
2014, November 2015), available at http://www.fsb.org/publications/?policy_area%5B%5D=24.
---------------------------------------------------------------------------

    The FDIC reviews incentive-based compensation practices as part of 
its safety and soundness examinations of state nonmember banks, most of 
which are smaller community institutions that would not be covered by 
the proposed rule. FDIC incentive-based compensation reviews are 
conducted in the context of the 2010 Federal Banking Agency Guidance 
and Section 39 of the FDIA. Of the 518 bank failures resolved by the 
FDIC between 2007 and 2015, 65 involved banks with total assets of $1 
billion or more that would have been covered by the proposed rule. Of 
the 65 institutions that failed with total assets of $1 billion or 
more, 18 institutions or approximately 28 percent, were identified as 
having some level of issues or concerns related to compensation 
arrangements, many of which involved incentive-based compensation. 
Overall, most of the compensation issues related to either excessive 
compensation or tying financial incentives to metrics such as corporate 
performance or loan production without adequate consideration of 
related risks. Also, several cases involved poor governance practices, 
most commonly, dominant

[[Page 37676]]

management influencing improper incentives.\22\
---------------------------------------------------------------------------

    \22\ The Inspector General of the appropriate federal banking 
agency must conduct a Material Loss Review (``MLR'') when losses to 
the Deposit Insurance Fund from failure of an insured depository 
institution exceed certain thresholds. See FDIC MLRs, available at 
https://www.fdicig.gov/mlr.shtml; Board MLRs available at http://oig.federalreserve.gov/reports/audit-reports.htm; and OCC MLRs, 
available at https://www.treasury.gov/about/organizational-structure/ig/Pages/audit_reports_index.aspx. See also the 
Subcommittee Report.
---------------------------------------------------------------------------

    The OCC reviews and assesses compensation practices at individual 
banks as part of its normal supervisory activities. For example, the 
OCC identifies matters requiring attention (MRAs) relating to 
compensation practices, including matters relating to governance and 
risk management and controls for compensation. The OCC's Guidelines 
Establishing Heightened Standards for Certain Large Insured National 
Banks, Insured Federal Savings Associations, and Insured Federal 
Branches \23\ (the ``OCC's Heightened Standards'') require covered 
banks to establish and adhere to compensation programs that prohibit 
incentive-based payment arrangements that encourage inappropriate risks 
by providing excessive compensation or that could lead to material 
financial loss. The OCC includes an assessment of the banks' 
compensation practices when determining compliance with the OCC's 
Heightened Standards.
---------------------------------------------------------------------------

    \23\ 12 CFR part 30, appendix D.
---------------------------------------------------------------------------

    In addition to safety and soundness oversight, FHFA has express 
statutory authorities and mandates related to compensation paid by its 
regulated entities. FHFA reviews compensation arrangements before they 
are implemented at Fannie Mae, Freddie Mac, the Federal Home Loan 
Banks, and the Office of Finance of the Federal Home Loan Bank System. 
By statute, FHFA must prohibit its regulated entities from providing 
compensation to any executive officer of a regulated entity that is not 
reasonable and comparable with compensation for employment in other 
similar businesses (including publicly held financial institutions or 
major financial services companies) involving similar duties and 
responsibilities.\24\ FHFA also has additional authority over the 
Enterprises during conservatorship, and has established compensation 
programs for Enterprise executives.\25\
---------------------------------------------------------------------------

    \24\ 12 U.S.C. 4518(a).
    \25\ As conservator, FHFA succeeded to all rights, titles, 
powers and privileges of the Enterprises, and of any shareholder, 
officer or director of each company with respect to the company and 
its assets. The Enterprises have been under conservatorship since 
September 2008.
---------------------------------------------------------------------------

    In early 2014, FHFA issued two final rules related to compensation 
pursuant to its authority over compensation under the Safety and 
Soundness Act.\26\ The Executive Compensation Rule sets forth 
requirements and processes with respect to compensation provided to 
executive officers by the Enterprises, the Federal Home Loan Banks, and 
the Federal Home Loan Bank System's Office of Finance.\27\ Under the 
rule, those entities may not enter into an incentive plan with an 
executive officer or pay any incentive compensation to an executive 
officer without providing advance notice to FHFA.\28\ FHFA's Golden 
Parachute Payments Rule governs golden parachute payments in the case 
of a regulated entity's insolvency, conservatorship, or troubled 
condition.\29\
---------------------------------------------------------------------------

    \26\ 12 CFR parts 1230 and 1231, under the authority of the 
Safety and Soundness Act (12 U.S.C. 4518), as amended by the Housing 
and Economic Recovery Act of 2008. Congress enacted HERA, including 
new or amended provisions addressing compensation at FHFA's 
regulated entities, at least in part in response to the financial 
crisis that began in 2007.
    \27\ 12 CFR part 1230.
    \28\ 12 CFR 1230.3(d).
    \29\ 12 CFR part 1231.
---------------------------------------------------------------------------

    In part because of the work described above, incentive-based 
compensation practices and the design of incentive-based compensation 
arrangements at banking organizations supervised by the Federal Banking 
Agencies have improved significantly in the years since the recent 
financial crisis. However, the Federal Banking Agencies have continued 
to evaluate incentive-based compensation practices as a part of their 
ongoing supervision responsibilities, with a particular focus on the 
design of incentive-based compensation arrangements for senior 
executive officers; deferral practices (including compensation at risk 
through forfeiture and clawback mechanisms); governance and the use of 
discretion; ex ante risk adjustment; and control function participation 
in incentive-based compensation design and risk evaluation. The Federal 
Banking Agencies' supervision has been focused on ensuring robust risk 
management and governance practices rather than on prescribing levels 
of pay.
    Generally, the supervisory work of the Federal Banking Agencies and 
FHFA has promoted more risk-sensitive incentive-based compensation 
practices and effective risk governance. Incentive-based compensation 
decision-making increasingly leverages underlying risk management 
frameworks to help ensure better risk identification, monitoring, and 
escalation of risk issues. Prior to the recent financial crisis, many 
institutions had no effective risk adjustments to incentive-based 
compensation at all. Today, the Board has observed that incentive-based 
compensation arrangements at the largest banking institutions reflect 
risk adjustments, the largest banking institutions take into 
consideration adverse outcomes, more pay is deferred, and more of the 
deferred amount is subject to reduction based on failure to meet 
assigned performance targets or as a result of adverse outcomes that 
trigger forfeiture and clawback reviews.\30\
---------------------------------------------------------------------------

    \30\ See generally 2011 FRB White Paper. The 2011 FRB White 
Paper provides specific examples of how compensation practices at 
the institutions involved in the Board's Horizontal Review of 
Incentive Compensation have changed since the recent financial 
crisis.
---------------------------------------------------------------------------

    Similarly, prior to the recent financial crisis, institutions 
rarely involved risk management and control personnel in incentive-
based compensation decision-making. Today, control functions frequently 
play an increased role in the design and operation of incentive-based 
compensation, and institutions have begun to build out frameworks to 
help validate the effectiveness of risk adjustment mechanisms. Risk-
related performance objectives and ``risk reviews'' are increasingly 
common. Prior to the recent financial crisis, boards of directors had 
begun to consider the relationship between incentive-based compensation 
and risk, but were focused on incentive-based compensation for senior 
executives. Today, refined policies and procedures promote some 
consistency and effectiveness across incentive-based compensation 
arrangements. The role of boards of directors has expanded and the 
quality of risk information provided to those boards has improved. 
Finance and audit committees work together with compensation committees 
with the goal of having incentive-based compensation result in prudent 
risk-taking.
    Notwithstanding the recent progress, incentive-based compensation 
practices are still in need of improvement, including better targeting 
of performance measures and risk metrics to specific activities, more 
consistent application of risk adjustments, and better documentation of 
the decision-making process. Congress has required the Agencies to 
jointly prescribe regulations or guidelines that cover not only 
depository institutions and depository institution holding companies, 
but also other financial institutions. While the Federal Banking 
Agencies' supervisory approach based on the 2010 Federal Banking Agency

[[Page 37677]]

Guidance and the work of FHFA have resulted in improved incentive-based 
compensation practices, there are even greater benefits possible under 
rule-based supervision. Using their collective supervisory experiences, 
the Agencies are proposing a uniform set of enforceable standards 
applicable to a larger group of institutions supervised by all of the 
Agencies. The proposed rule would promote better incentive-based 
compensation practices, while still allowing for some flexibility in 
the design and operation of incentive-based compensation arrangements 
among the varied institutions the Agencies supervise, including through 
the tiered application of the proposed rule's requirements.

C. Overview of the 2011 Proposed Rule and Public Comment

    The Agencies proposed a rule in 2011, rather than guidelines, to 
establish requirements applicable to the incentive-based compensation 
arrangements of all covered institutions. The 2011 Proposed Rule would 
have supplemented existing rules, guidance, and ongoing supervisory 
efforts of the Agencies.
    The 2011 Proposed Rule would have prohibited incentive-based 
compensation arrangements that could encourage inappropriate risks. It 
would have required compensation practices at regulated financial 
institutions to be consistent with three key principles--that 
incentive-based compensation arrangements should appropriately balance 
risk and financial rewards, be compatible with effective risk 
management and controls, and be supported by strong corporate 
governance. The Agencies proposed that financial institutions with $1 
billion or more in assets be required to have policies and procedures 
to ensure compliance with the requirements of the rule, and submit an 
annual report to their Federal regulator describing the structure of 
their incentive-based compensation arrangements.
    The 2011 Proposed Rule included two additional requirements for 
``larger financial institutions.'' \31\ The first would have required 
these larger financial institutions to defer 50 percent of the 
incentive-based compensation for executive officers for a period of at 
least three years. The second would have required the board of 
directors (or a committee thereof) to identify and approve the 
incentive-based compensation for those covered persons who individually 
have the ability to expose the institution to possible losses that are 
substantial in relation to the institution's size, capital, or overall 
risk tolerance, such as traders with large position limits and other 
individuals who have the authority to place at risk a substantial part 
of the capital of the covered institution.
---------------------------------------------------------------------------

    \31\ In the 2011 Proposed Rule, the term ``larger covered 
financial institution'' for the Federal Banking Agencies and the SEC 
meant those covered institutions with total consolidated assets of 
$50 billion or more. For the NCUA, all credit unions with total 
consolidated assets of $10 billion or more would have been larger 
covered institutions. For FHFA, Fannie Mae, Freddie Mac, and all 
Federal Home Loan Banks with total consolidated assets of $1 billion 
or more would have been larger covered institutions.
---------------------------------------------------------------------------

    The Agencies received more than 10,000 comments on the 2011 
Proposed Rule, including from private individuals, community groups, 
several members of Congress, pension funds, labor federations, academic 
faculty, covered institutions, financial industry associations, and 
industry consultants.
    The vast majority of the comments were substantively identical form 
letters of two types. The first type of form letter urged the Agencies 
to minimize the incentives for short-term risk-taking by executives by 
requiring at least a five-year deferral period for executive bonuses at 
big banks, banning executives' hedging of their pay packages, and 
requiring specific details from banks on precisely how they ensure that 
executives will share in the long-term risks created by their 
decisions. These commenters also asserted that the final rule should 
apply to the full range of important financial institutions and cover 
all the key executives at those institutions. The second type of form 
letter stated that the commenter or the commenter's family had been 
affected by the financial crisis that began in 2007, a major cause of 
which the commenter believed to be faulty pay practices at financial 
institutions. These commenters suggested various methods of improving 
these practices, including basing incentive-based compensation on 
measures of a financial institution's safety and stability, such as the 
institution's bond price or the spread on credit default swaps.
    Comments from community groups, members of Congress, labor 
federations, and pension funds generally urged the Agencies to 
strengthen the proposed rule and many cited evidence suggesting that 
flawed incentive-based compensation practices in the financial industry 
were a major contributing factor to the recent financial crisis. Their 
suggestions included: Revising the 2011 Proposed Rule's definition of 
``incentive-based compensation''; defining ``excessive compensation''; 
increasing the length of time for or amount of compensation subject to 
the mandatory deferral provision; requiring financial institutions to 
include quantitative data in their annual incentive-based compensation 
reports; providing for the annual public reporting by the Agencies of 
information quantifying the overall sensitivity of incentive-based 
compensation to long-term risks at major financial institutions; 
prohibiting stock ownership by board members; and prohibiting hedging 
strategies used by highly-paid executives on their own incentive-based 
compensation.
    The academic faculty commenters submitted analyses of certain 
compensation issues and recommendations. These recommendations 
included: Adopting a corporate governance measure tied to stock 
ownership by board members; regulating how deferred compensation is 
reduced at future payment dates; requiring covered institutions' 
executives to have ``skin in the game'' for the entire deferral period; 
and requiring disclosure of personal hedging transactions rather than 
prohibiting them.
    A number of covered institutions and financial industry 
associations favored the issuance of guidelines instead of rules to 
implement section 956. Others expressed varying degrees of support for 
the 2011 Proposed Rule but also requested numerous clarifications and 
modifications. Many of these commenters raised questions concerning the 
2011 Proposed Rule's scope, suggesting that certain types of 
institutions be excluded from the coverage of the final rule. Some of 
these commenters questioned the need for the excessive compensation 
prohibition or requested that the final rule provide specific standards 
for determining when compensation is excessive. Many of these 
commenters also opposed the 2011 Proposed Rule's mandatory deferral 
provision, and some asserted that the provision was unsupported by 
empirical evidence and potentially harmful to a covered institution's 
ability to attract and retain key employees. In addition, many of these 
commenters asserted that the material risk-taker provision in the 2011 
Proposed Rule was unclear or imposed on the boards of directors of 
covered institutions duties more appropriately undertaken by the 
institutions' management. Finally, these commenters expressed concerns 
about the burden and timing of the 2011 Proposed Rule.

D. International Developments

    The Agencies considered international developments in

[[Page 37678]]

developing the 2011 Proposed Rule, mindful that some covered 
institutions operate in both domestic and international competitive 
environments.\32\ Since the release of the 2011 Proposed Rule, a number 
of foreign jurisdictions have introduced new compensation regulations 
that require certain financial institutions to meet certain standards 
in relation to compensation policies and practices. In June 2013, the 
European Union adopted the Capital Requirements Directive (``CRD'') IV, 
which sets out requirements for compensation structures, policies, and 
practices that apply to all banks and investment firms subject to the 
CRD.\33\ The rules require that up to 100 percent of the variable 
remuneration shall be subject to malus \34\ or clawback arrangements, 
among other requirements.\35\ The PRA's and the FCA's Remuneration Code 
requires covered companies to defer 40 to 60 percent of a covered 
person's variable remuneration--and recently updated their implementing 
regulations to extend deferral periods to seven years for senior 
executives and to five years for certain other covered persons.\36\ The 
PRA also implemented, in July 2014, a policy requiring firms to set 
specific criteria for the application of malus and clawback. The PRA's 
clawback policy requires that variable remuneration be subject to 
clawback for a period of at least seven years from the date on which it 
is awarded.\37\
---------------------------------------------------------------------------

    \32\ See 76 FR at 21178. See, e.g., FSB Principles and 
Implementation Standards.
    \33\ Directive 2013/36/EU of the European Parliament and of the 
Council of 26 June 2013 (effective January 1, 2014). The 
remuneration rules in CRD IV were carried over from CRD III with a 
few additional requirements. CRD III directed the Committee of 
European Bank Supervisors (``CEBS''), now the European Banking 
Authority (``EBA''), to develop guidance on how it expected the 
compensation principles under CRD III to be implemented. See CEBS 
Guidelines on Remuneration Policies and Practices (December 10, 
2010) (``CEBS Guidelines''), available at http://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32010L0076&from=EN.
    \34\ Malus is defined by the European Union as ``an arrangement 
that permits the institution to prevent vesting of all or part of 
the amount of a deferred remuneration award in relation to risk 
outcomes or performance.'' See, PRA expectations regarding the 
application of malus to variable remuneration--SS2/13 UPDATE, 
available at: http://www.bankofengland.co.uk/pra/Documents/publications/ss/2015/ss213update.pdf.
    \35\ CRD IV provides that at least 50 percent of total variable 
remuneration should consist of equity-linked interests and at least 
40 percent of any variable remuneration must be deferred over a 
period of three to five years. In the case of variable remuneration 
of a particularly high amount, the minimum amount required to be 
deferred is increased to 60 percent.
    \36\ See UK Remuneration Rules.
    \37\ See PRA, ``PRA PS7/14: Clawback'' (July 2014), available at 
http://www.bankofengland.co.uk/pra/Pages/publications/ps/2014/ps714.aspx.
---------------------------------------------------------------------------

    Also in 2013, the EBA finalized the process and criteria for the 
identification of categories of staff who have a material impact on the 
institution's risk profile (``Identified Staff'').\38\ These Identified 
Staff are subject to provisions related, in particular, to the payment 
of variable compensation. The standards cover remuneration packages for 
Identified Staff categories and aim to ensure that appropriate 
incentives for prudent, long-term oriented risk-taking are provided. 
The criteria used to determine who is identified are both qualitative 
(i.e., related to the role and decision-making authority of staff 
members) and quantitative (i.e., related to the level of total gross 
remuneration in absolute or in relative terms).
---------------------------------------------------------------------------

    \38\ EBA Regulatory Technical Standards on criteria to identify 
categories of staff whose professional activities have a material 
impact on an institution's risk profile under Article 94(2) of 
Directive 2013/36/EU. Directive 2013/36/EU of the European 
Parliament and of the Council of 26 June 2013 (December 16, 2013), 
available at https://www.eba.europa.eu/documents/10180/526386/EBA-RTS-2013-11+%28On+identified+staff%29.pdf/c313a671-269b-45be-a748-29e1c772ee0e.
---------------------------------------------------------------------------

    More recently, in December 2015, the EBA released its final 
Guidelines on Sound Remuneration Policies.\39\ The final Guidelines on 
Sound Remuneration Policies set out the governance process for 
implementing sound compensation policies across the European Union 
under CRD IV, as well as the specific criteria for categorizing all 
compensation components as either fixed or variable pay. The final 
Guidelines on Sound Remuneration Policies also provide guidance on the 
application of deferral arrangements and pay-out instruments to ensure 
that variable pay is aligned with an institution's long-term risks and 
that any ex-post risk adjustments can be applied as appropriate. These 
Guidelines will apply as of January 1, 2017, and will replace the 
Guidelines on Remuneration Policies and Practices that were published 
by the CEBS in December 2010.
---------------------------------------------------------------------------

    \39\ EBA, ``Guidelines for Sound Remuneration Policies under 
Articles 74(3) and 75(2) of Directive 2013/36/EU and Disclosures 
under Article 450 of Regulation (EU) No 575/2013'' (December 21, 
2015) (``EBA Remuneration Guidelines''), available at https://www.eba.europa.eu/documents/10180/1314839/EBA-GL-2015-22+Guidelines+on+Sound+Remuneration+Policies.pdf/1b0f3f99-f913-461a-b3e9-fa0064b1946b.
---------------------------------------------------------------------------

    Other regulators, including those in Canada, Australia, and 
Switzerland, have taken either a guidance-based approach to the 
supervision and regulation of incentive-based compensation or an 
approach that combines guidance and regulation that is generally 
consistent with the FSB Principles and Implementation Standards. In 
Australia,\40\ all deposit-taking institutions and insurers are 
expected to comply in full with all the requirements in the APRA's 
Governance standard (which includes remuneration provisions). APRA also 
supervises according to its Remuneration Prudential Practice Guide 
(guidance). In Canada,\41\ all federally regulated financial 
institutions (domestic and foreign) are expected to comply with the FSB 
Principles and Implementation Standards, and the six Domestic 
Systemically Important Banks and three largest life insurance companies 
are expected to comply with the FSB's Principles and Implementation 
Standards. OSFI has also issued a Corporate Governance Guideline that 
contain compensation provisions.\42\ Switzerland's Swiss Financial 
Markets Supervisory Authority has also published a principles-based 
rule on remuneration consistent with the FSB Principles and 
Implementation Standards that applies to major banks and insurance 
companies.\43\
---------------------------------------------------------------------------

    \40\ See APRA, ``Prudential Standard CPS 510 Governance'' 
(January 2015), available at http://www.apra.gov.au/CrossIndustry/Documents/Final-Prudential-Standard-CPS-510-Governance-%28January-2014%29.pdf; APRA, Prudential Practice Guide PPG 511--Remuneration 
(November 30, 2009), available at http://www.apra.gov.au/adi/PrudentialFramework/Pages/adi-prudential-framework.aspx.
    \41\ See OSFI Corporate Governance Guidelines and OSFI 
Supervisory Framework.
    \42\ See OSFI Corporate Governance Guidelines.
    \43\ See FINMA Remuneration Circular.
---------------------------------------------------------------------------

    As compensation practices continue to evolve, the Agencies 
recognize that international coordination in this area is important to 
ensure that internationally active financial organizations are subject 
to consistent requirements. For this reason, the Agencies will continue 
to work with their domestic and international counterparts to foster 
sound compensation practices across the financial services industry. 
Importantly, the proposed rule is consistent with the FSB Principles 
and Implementation Standards.

E. Overview of the Proposed Rule

    The Agencies are re-proposing a rule, rather than proposing 
guidelines, to establish general requirements applicable to the 
incentive-based compensation arrangements of all covered institutions. 
Like the 2011 Proposed Rule, the proposed rule would prohibit 
incentive-based compensation arrangements at covered institutions that 
could encourage inappropriate risks by providing excessive compensation 
or that could lead to a material financial

[[Page 37679]]

loss. However, the proposed rule reflects the Agencies' collective 
supervisory experiences since they proposed the 2011 Proposed Rule. 
These supervisory experiences, which are described above, have allowed 
the Agencies to propose a rule that incorporates practices that 
financial institutions and foreign regulators have adopted to address 
the deficiencies in incentive-based compensation practices that helped 
contribute to the financial crisis that began in 2007. For that reason, 
the proposed rule differs in some respects from the 2011 Proposed Rule. 
This section provides a general overview of the proposed rule and 
highlights areas in which the proposed rule differs from the 2011 
Proposed Rule. A more detailed, section-by-section description of the 
proposed rule and the reasons for the proposed rule's requirements is 
provided later in this Supplementary Information section.
    Scope and Initial Applicability. Similar to the 2011 Proposed Rule, 
the proposed rule would apply to any covered institution with average 
total consolidated assets greater than or equal to $1 billion that 
offers incentive-based compensation to covered persons.
    The compliance date of the proposed rule would be no later than the 
beginning of the first calendar quarter that begins at least 540 days 
after a final rule is published in the Federal Register. The proposed 
rule would not apply to any incentive-based compensation plan with a 
performance period that begins before the compliance date.
    Definitions. The proposed rule includes a number of new definitions 
that were not included in the 2011 Proposed Rule. These definitions are 
described later in the section-by-section analysis in this 
Supplementary Information section. Notably, the Agencies have added a 
definition of significant risk-taker, which is intended to include 
individuals who are not senior executive officers but who are in the 
position to put a Level 1 or Level 2 covered institution at risk of 
material financial loss. This definition is explained in more detail 
below.
    Applicability. The proposed rule distinguishes covered institutions 
by asset size, applying less prescriptive incentive-based compensation 
program requirements to the smallest covered institutions within the 
statutory scope and progressively more rigorous requirements to the 
larger covered institutions. Although the 2011 Proposed Rule contained 
specific requirements for covered financial institutions with at least 
$50 billion in total consolidated assets, the proposed rule creates an 
additional category of institutions with at least $250 billion in 
average total consolidated assets. These larger institutions are 
subject to the most rigorous requirements under the proposed rule.
    The proposed rule identifies three categories of covered 
institutions based on average total consolidated assets: \44\
---------------------------------------------------------------------------

    \44\ For covered institutions that are subsidiaries of other 
covered institutions, levels would generally be determined by 
reference to the average total consolidated assets of the top-tier 
parent covered institution. A detailed explanation of consolidation 
under the proposed rule is included under the heading ``Definitions 
pertaining to covered institutions'' below in this Supplementary 
Information section.
---------------------------------------------------------------------------

     Level 1 (greater than or equal to $250 billion);
     Level 2 (greater than or equal to $50 billion and less 
than $250 billion); and
     Level 3 (greater than or equal to $1 billion and less than 
$50 billion).\45\
---------------------------------------------------------------------------

    \45\ As explained later in this Supplementary Information 
section, the proposed rule includes a reservation of authority that 
would allow the appropriate Federal regulator of a Level 3 covered 
institution with average total consolidated assets greater than or 
equal to $10 billion and less than $50 billion to require the Level 
3 covered institution to comply with some or all of the provisions 
of sections __.5 and __.7 through __.11 of the proposed rule if the 
agency determines that the complexity of operations or compensation 
practices of the Level 3 covered institution are consistent with 
those of a Level 1 or Level 2 covered institution.
---------------------------------------------------------------------------

    Upon an increase in average total consolidated assets, a covered 
institution would be required to comply with any newly applicable 
requirements under the proposed rule no later than the first day of the 
first calendar quarter that begins at least 540 days after the date on 
which the covered institution becomes a Level 1, Level 2, or Level 3 
covered institution. The proposed rule would grandfather any incentive-
based compensation plan with a performance period that begins before 
such date. Upon a decrease in total consolidated assets, a covered 
institution would remain subject to the provisions of the proposed rule 
that applied to it before the decrease until total consolidated assets 
fell below $250 billion, $50 billion, or $1 billion, as applicable, for 
four consecutive regulatory reports (e.g., Call Reports).
    A covered institution under the Board's, the OCC's, or the FDIC's 
proposed rule that is a subsidiary of another covered institution under 
the Board's, the OCC's, or the FDIC's proposed rule, respectively, may 
meet any requirement of the Board's, OCC's, or the FDIC's proposed rule 
if the parent covered institution complies with that requirement in 
such a way that causes the relevant portion of the incentive-based 
compensation program of the subsidiary covered institution to comply 
with that requirement.
    Requirements and Prohibitions Applicable to All Covered 
Institutions. Similar to the 2011 Proposed Rule, the proposed rule 
would prohibit all covered institutions from establishing or 
maintaining incentive-based compensation arrangements that encourage 
inappropriate risk by providing covered persons with excessive 
compensation, fees, or benefits or that could lead to material 
financial loss to the covered institution.
    Also consistent with the 2011 Proposed Rule, the proposed rule 
provides that compensation, fees, and benefits will be considered 
excessive when amounts paid are unreasonable or disproportionate to the 
value of the services performed by a covered person, taking into 
consideration all relevant factors, including:
     The combined value of all compensation, fees, or benefits 
provided to a covered person;
     The compensation history of the covered person and other 
individuals with comparable expertise at the covered institution;
     The financial condition of the covered institution;
     Compensation practices at comparable institutions, based 
upon such factors as asset size, geographic location, and the 
complexity of the covered institution's operations and assets;
     For post-employment benefits, the projected total cost and 
benefit to the covered institution; and
     Any connection between the covered person and any 
fraudulent act or omission, breach of trust or fiduciary duty, or 
insider abuse with regard to the covered institution.
    The proposed rule is also similar to the 2011 Proposed Rule in that 
it provides that an incentive-based compensation arrangement will be 
considered to encourage inappropriate risks that could lead to material 
financial loss to the covered institution, unless the arrangement:
     Appropriately balances risk and reward;
     Is compatible with effective risk management and controls; 
and
     Is supported by effective governance.
    However, unlike the 2011 Proposed Rule, the proposed rule 
specifically provides that an incentive-based compensation arrangement 
would not be considered to appropriately balance risk and reward unless 
it:
     Includes financial and non-financial measures of 
performance;

[[Page 37680]]

     Is designed to allow non-financial measures of performance 
to override financial measures of performance, when appropriate; and
     Is subject to adjustment to reflect actual losses, 
inappropriate risks taken, compliance deficiencies, or other measures 
or aspects of financial and non-financial performance.
    The proposed rule also contains requirements for the board of 
directors of a covered institution that are similar to requirements 
included in the 2011 Proposed Rule. Under the proposed rule, the board 
of directors of each covered institution (or a committee thereof) would 
be required to:
     Conduct oversight of the covered institution's incentive-
based compensation program;
     Approve incentive-based compensation arrangements for 
senior executive officers, including amounts of awards and, at the time 
of vesting, payouts under such arrangements; and
     Approve material exceptions or adjustments to incentive-
based compensation policies or arrangements for senior executive 
officers.
    The 2011 Proposed Rule contained an annual reporting requirement, 
which has been replaced by a recordkeeping requirement in the proposed 
rule. Covered institutions would be required to create annually and 
maintain for at least seven years records that document the structure 
of incentive-based compensation arrangements and that demonstrate 
compliance with the proposed rule. The records would be required to be 
disclosed to the covered institution's appropriate Federal regulator 
upon request.
    Disclosure and Recordkeeping Requirements for Level 1 and Level 2 
Covered Institutions. The proposed rule includes more detailed 
disclosure and recordkeeping requirements for larger covered 
institutions than the 2011 Proposed Rule. The proposed rule would 
require all Level 1 and Level 2 covered institutions to create annually 
and maintain for at least seven years records that document: (1) The 
covered institution's senior executive officers and significant risk-
takers, listed by legal entity, job function, organizational hierarchy, 
and line of business; (2) the incentive-based compensation arrangements 
for senior executive officers and significant risk-takers, including 
information on the percentage of incentive-based compensation deferred 
and form of award; (3) any forfeiture and downward adjustment or 
clawback reviews and decisions for senior executive officers and 
significant risk-takers; and (4) any material changes to the covered 
institution's incentive-based compensation arrangements and policies. 
Level 1 and Level 2 covered institutions would be required to create 
and maintain records in a manner that would allow for an independent 
audit of incentive-based compensation arrangements, policies, and 
procedures, and to provide the records described above in such form and 
frequency as the appropriate Federal regulator requests.
    Deferral, Forfeiture and Downward Adjustment, and Clawback 
Requirements for Level 1 and Level 2 Covered Institutions. The proposed 
rule would require incentive-based compensation arrangements that 
appropriately balance risk and reward. For Level 1 and Level 2 covered 
institutions, the proposed rule would require that incentive-based 
compensation arrangements for certain covered persons include deferral 
of payments, risk of downward adjustment and forfeiture, and clawback 
to appropriately balance risk and reward. The 2011 Proposed Rule 
required deferral for three years of 50 percent of annual incentive-
based compensation for executive officers of covered financial 
institutions with $50 billion or more in total consolidated assets. The 
proposed rule would apply deferral requirements to significant risk-
takers as well as senior executive officers, and, as described below, 
would require 40, 50, or 60 percent deferral depending on the size of 
the covered institution and whether the covered person receiving the 
incentive-based compensation is a senior executive officer or a 
significant risk-taker. Unlike the 2011 Proposed Rule, the proposed 
rule would explicitly require a shorter deferral period for incentive-
based compensation awarded under a long-term incentive plan. The 
proposed rule also provides more detailed requirements and prohibitions 
than the 2011 Proposed Rule with respect to the measurement, 
composition, and acceleration of deferred incentive-based compensation; 
the manner in which deferred incentive-based compensation can vest; 
increases to the amount of deferred incentive-based compensation; and 
the amount of deferred incentive-based compensation that can be in the 
form of options.
    Deferral. Under the proposed rule, the mandatory deferral 
requirements for Level 1 and Level 2 covered institutions for 
incentive-based compensation awarded each performance period would be 
as follows:
     A Level 1 covered institution would be required to defer 
at least 60 percent of a senior executive officer's ``qualifying 
incentive-based compensation'' (as defined in the proposed rule) and 50 
percent of a significant risk-taker's qualifying incentive-based 
compensation for at least four years. A Level 1 covered institution 
also would be required to defer for at least two years after the end of 
the related performance period at least 60 percent of a senior 
executive officer's incentive-based compensation awarded under a 
``long-term incentive plan'' (as defined in the proposed rule) and 50 
percent of a significant risk-taker's incentive-based compensation 
awarded under a long-term incentive plan. Deferred compensation may 
vest no faster than on a pro rata annual basis, and, for covered 
institutions that issue equity or are subsidiaries of covered 
institutions that issue equity, the deferred amount would be required 
to consist of substantial amounts of both deferred cash and equity-like 
instruments throughout the deferral period. Additionally, if a senior 
executive officer or significant risk-taker receives incentive-based 
compensation in the form of options for a performance period, the 
amount of such options used to meet the minimum required deferred 
compensation may not exceed 15 percent of the amount of total 
incentive-based compensation awarded for that performance period.
     A Level 2 covered institution would be required to defer 
at least 50 percent of a senior executive officer's qualifying 
incentive-based compensation and 40 percent of a significant risk-
taker's qualifying incentive-based compensation for at least three 
years. A Level 2 covered institution also would be required to defer 
for at least one year after the end of the related performance period 
at least 50 percent of a senior executive officer's incentive-based 
compensation awarded under a long-term incentive plan and 40 percent of 
a significant risk-taker's incentive-based compensation awarded under a 
long-term incentive plan. Deferred compensation may vest no faster than 
on a pro rata annual basis, and, for covered institutions that issue 
equity or are subsidiaries of covered institutions that issue equity, 
the deferred amount would be required to consist of substantial amounts 
of both deferred cash and equity-like instruments throughout the 
deferral period. Additionally, if a senior executive officer or 
significant risk-taker receives incentive-based compensation in the 
form of options for a performance period, the amount of such options 
used to meet the minimum required deferred compensation may not exceed 
15 percent of the amount of total incentive-based compensation awarded 
for that performance period.

[[Page 37681]]

    The proposed rule would also prohibit Level 1 and Level 2 covered 
institutions from accelerating the payment of a covered person's 
deferred incentive-based compensation, except in the case of death or 
disability of the covered person.
    Forfeiture and Downward Adjustment. Compared to the 2011 Proposed 
Rule, the proposed rule provides more detailed requirements for Level 1 
and Level 2 covered institutions to reduce (1) incentive-based 
compensation that has not yet been awarded to a senior executive 
officer or significant risk-taker, and (2) deferred incentive-based 
compensation of a senior executive officer or significant risk-taker. 
Under the proposed rule, ``forfeiture'' means a reduction of the amount 
of deferred incentive-based compensation awarded to a person that has 
not vested. ``Downward adjustment'' means a reduction of the amount of 
a covered person's incentive-based compensation not yet awarded for any 
performance period that has already begun. The proposed rule would 
require a Level 1 or Level 2 covered institution to make subject to 
forfeiture all unvested deferred incentive-based compensation of any 
senior executive officer or significant risk-taker, including unvested 
deferred amounts awarded under long-term incentive plans. This 
forfeiture requirement would apply to all unvested, deferred incentive-
based compensation for those individuals, regardless of whether the 
deferral was required by the proposed rule. Similarly, a Level 1 or 
Level 2 covered institution would also be required to make subject to 
downward adjustment all incentive-based compensation amounts not yet 
awarded to any senior executive officer or significant risk-taker for 
the current performance period, including amounts payable under long-
term incentive plans. A Level 1 or Level 2 covered institution would be 
required to consider forfeiture or downward adjustment of incentive-
based compensation if any of the following adverse outcomes occur:
     Poor financial performance attributable to a significant 
deviation from the covered institution's risk parameters set forth in 
the covered institution's policies and procedures;
     Inappropriate risk-taking, regardless of the impact on 
financial performance;
     Material risk management or control failures;
     Non-compliance with statutory, regulatory, or supervisory 
standards resulting in enforcement or legal action brought by a federal 
or state regulator or agency, or a requirement that the covered 
institution report a restatement of a financial statement to correct a 
material error; and
     Other aspects of conduct or poor performance as defined by 
the covered institution.
    Clawback. In addition to deferral, downward adjustment, and 
forfeiture, the proposed rule would require a Level 1 or Level 2 
covered institution to include clawback provisions in the incentive-
based compensation arrangements for senior executive officers and 
significant risk-takers. The term ``clawback'' refers to a mechanism by 
which a covered institution can recover vested incentive-based 
compensation from a senior executive officer or significant risk-taker 
if certain events occur. The proposed rule would require clawback 
provisions that, at a minimum, allow the covered institution to recover 
incentive-based compensation from a current or former senior executive 
officer or significant risk-taker for seven years following the date on 
which such compensation vests, if the covered institution determines 
that the senior executive officer or significant risk-taker engaged in 
misconduct that resulted in significant financial or reputational harm 
to the covered institution, fraud, or intentional misrepresentation of 
information used to determine the senior executive officer or 
significant risk-taker's incentive-based compensation. The 2011 
Proposed Rule did not include a clawback requirement.
    Additional Prohibitions. The proposed rule contains a number of 
additional prohibitions for Level 1 and Level 2 covered institutions 
that were not included in the 2011 Proposed Rule. These prohibitions 
would apply to:
     Hedging;
     Maximum incentive-based compensation opportunity (also 
referred to as leverage);
     Relative performance measures; and
     Volume-driven incentive-based compensation.
    Risk Management and Controls. The proposed rule's risk management 
and controls requirements for large covered institutions are generally 
more extensive than the requirements contained in the 2011 Proposed 
Rule. The proposed rule would require all Level 1 and Level 2 covered 
institutions to have a risk management framework for their incentive-
based compensation programs that is independent of any lines of 
business; includes an independent compliance program that provides for 
internal controls, testing, monitoring, and training with written 
policies and procedures; and is commensurate with the size and 
complexity of the covered institution's operations. In addition, the 
proposed rule would require Level 1 and Level 2 covered institutions 
to:
     Provide individuals in control functions with appropriate 
authority to influence the risk-taking of the business areas they 
monitor and ensure covered persons engaged in control functions are 
compensated independently of the performance of the business areas they 
monitor; and
     Provide for independent monitoring of: (1) Incentive-based 
compensation plans to identify whether the plans appropriately balance 
risk and reward; (2) events related to forfeiture and downward 
adjustment and decisions of forfeiture and downward adjustment reviews 
to determine consistency with the proposed rule; and (3) compliance of 
the incentive-based compensation program with the covered institution's 
policies and procedures.
    Governance. Unlike the 2011 Proposed Rule, the proposed rule would 
require each Level 1 or Level 2 covered institution to establish a 
compensation committee composed solely of directors who are not senior 
executive officers to assist the board of directors in carrying out its 
responsibilities under the proposed rule. The compensation committee 
would be required to obtain input from the covered institution's risk 
and audit committees, or groups performing similar functions, and risk 
management function on the effectiveness of risk measures and 
adjustments used to balance incentive-based compensation arrangements. 
Additionally, management would be required to submit to the 
compensation committee on an annual or more frequent basis a written 
assessment of the effectiveness of the covered institution's incentive-
based compensation program and related compliance and control processes 
in providing risk-taking incentives that are consistent with the risk 
profile of the covered institution. The compensation committee would 
also be required to obtain an independent written assessment from the 
internal audit or risk management function of the effectiveness of the 
covered institution's incentive-based compensation program and related 
compliance and control processes in providing risk-taking incentives 
that are consistent with the risk profile of the covered institution.
    Policies and Procedures. The proposed rule would require all Level 
1 and Level 2 covered institutions to have policies and procedures 
that, among other requirements:
     Are consistent with the requirements and prohibitions of 
the proposed rule;

[[Page 37682]]

     Specify the substantive and procedural criteria for 
forfeiture and clawback;
     Document final forfeiture, downward adjustment, and 
clawback decisions;
     Specify the substantive and procedural criteria for the 
acceleration of payments of deferred incentive-based compensation to a 
covered person;
     Identify and describe the role of any employees, 
committees, or groups authorized to make incentive-based compensation 
decisions, including when discretion is authorized;
     Describe how discretion is exercised to achieve balance;
     Require that the covered institution maintain 
documentation of its processes for the establishment, implementation, 
modification, and monitoring of incentive-based compensation 
arrangements;
     Describe how incentive-based compensation arrangements 
will be monitored;
     Specify the substantive and procedural requirements of the 
independent compliance program; and
     Ensure appropriate roles for risk management, risk 
oversight, and other control personnel in the covered institution's 
processes for designing incentive-based compensation arrangements and 
determining awards, deferral amounts, deferral periods, forfeiture, 
downward adjustment, clawback, and vesting and assessing the 
effectiveness of incentive-based compensation arrangements in 
restraining inappropriate risk-taking.
    These policies and procedures requirements for Level 1 and Level 2 
covered institutions are generally more detailed than the requirements 
in the 2011 Proposed Rule.
    Indirect Actions. The proposed rule would prohibit covered 
institutions from doing indirectly, or through or by any other person, 
anything that would be unlawful for the covered institution to do 
directly under the proposed rule. This prohibition is similar to the 
evasion provision contained in the 2011 Proposed Rule.
    Enforcement. For five of the Agencies, the proposed rule would be 
enforced under section 505 of the Gramm-Leach-Bliley Act, as specified 
in section 956. For FHFA, the proposed rule would be enforced under 
subtitle C of the Safety and Soundness Act.
    Conservatorship or Receivership for Certain Covered Institutions. 
FHFA's and NCUA's proposed rules contain provisions that would apply to 
covered institutions that are managed by a government agency or a 
government-appointed agent, or that are in conservatorship or 
receivership or are limited-life regulated entities under the Safety 
and Soundness Act or the Federal Credit Union Act.\46\
---------------------------------------------------------------------------

    \46\ The FDIC's proposed rule would not apply to institutions 
for which the FDIC is appointed receiver under the FDIA or Title II 
of the Dodd-Frank Act, as appropriate, as those statutes govern such 
cases.
---------------------------------------------------------------------------

    A detailed description of the proposed rule and requests for 
comments are set forth below.

II. Section-by-Section Description of the Proposed Rule

Sec.  __.1 Authority, Scope and Initial Applicability

    Section __.1 provides that the proposed rule is issued pursuant to 
section 956. The Agencies also have listed applicable additional 
rulemaking authority in their respective authority citations.
    The OCC is issuing the proposed rule under its general rulemaking 
authority, 12 U.S.C. 93a and the Home Owners' Loan Act, 12 U.S.C. 1461 
et seq., its safety and soundness authority under 12 U.S.C. 1818, and 
its authority to regulate compensation under 12 U.S.C. 1831p-1.
    The Board is issuing the proposed rule under its safety and 
soundness authority under section 5136 of the Revised Statutes (12 
U.S.C. 24), the Federal Reserve Act (12 U.S.C. 321-338a), the FDIA (12 
U.S.C. 1818), the Bank Holding Company Act (12 U.S.C. 1844(b)), the 
Home Owners' Loan Act (12 U.S.C. 1462a and 1467a), and the 
International Banking Act (12 U.S.C. 3108).
    The FDIC is issuing the proposed rule under its general rulemaking 
authority, 12 U.S.C. 1819 Tenth, as well as its general safety and 
soundness authority under 12 U.S.C. 1818 and authority to regulate 
compensation under 12 U.S.C. 1831p-1.
    FHFA is issuing the proposed rule pursuant to its authority under 
the Safety and Soundness Act (particularly 12 U.S.C. 4511(b), 4513, 
4514, 4518, 4526, and ch. 46 subch. III.).
    NCUA is issuing the proposed rule under its general rulemaking and 
safety and soundness authorities in the Federal Credit Union Act, 12 
U.S.C. 1751 et seq.
    The SEC is issuing the proposed rule pursuant to its rulemaking 
authority under the Securities Exchange Act of 1934 and the Investment 
Advisers Act of 1940 (15 U.S.C. 78q, 78w, 80b-4, and 80b-11).
    The approach taken in the proposed rule is within the authority 
granted by section 956. The proposed rule would prohibit types and 
features of incentive-based compensation arrangements that encourage 
inappropriate risks. As explained more fully below, incentive-based 
compensation arrangements that result in payments that are unreasonable 
or disproportionate to the value of services performed could encourage 
inappropriate risks by providing excessive compensation, fees, and 
benefits. Further, incentive-based compensation arrangements that do 
not appropriately balance risk and reward, that are not compatible with 
effective risk management and controls, or that are not supported by 
effective governance are the types of incentive-based compensation 
arrangements that could encourage inappropriate risks that could lead 
to material financial loss to covered institutions. Because these types 
of incentive-based compensation arrangements encourage inappropriate 
risks, they would be prohibited under the proposed rule.
    The Federal Banking Agencies have found that any incentive-based 
compensation arrangement at a covered institution will encourage 
inappropriate risks if it does not sufficiently expose the risk-takers 
to the consequences of their risk decisions over time, and that in 
order to do this, it is necessary that meaningful portions of 
incentive-based compensation be deferred and placed at risk of 
reduction or recovery. The proposed rule reflects the minimums that are 
required to be effective for that purpose, as well as minimum standards 
of robust governance, and the disclosures that the statute requires. 
The Agencies' position in this respect is informed by the country's 
experience in the recent financial crisis, as well as by their 
experience supervising their respective institutions and their 
observation of the experience and judgments of regulators in other 
countries.
    Consistent with section 956, section __.1 provides that the 
proposed rule would apply to a covered institution with average total 
consolidated assets greater than or equal to $1 billion that offers 
incentive-based compensation arrangements to covered persons.
    The Agencies propose the compliance date of the proposed rule to be 
the beginning of the first calendar quarter that begins at least 540 
days after the final rule is published in the Federal Register. Any 
incentive-based compensation plan with a performance period that begins 
before such date would not be required to comply with the requirements 
of the proposed rule. Whether a covered institution is a Level 1, Level 
2, or Level 3 covered

[[Page 37683]]

institution \47\ on the compliance date would be determined based on 
average total consolidated assets as of the beginning of the first 
calendar quarter that begins after a final rule is published in the 
Federal Register. For example, if the final rule is published in the 
Federal Register on November 1, 2016, then the compliance date would be 
July 1, 2018. In that case, any incentive-based compensation plan with 
a performance period that began before July 1, 2018 would not be 
required to comply with the rule. Whether a covered institution is a 
Level 1, Level 2, or Level 3 covered institution on July 1, 2018 would 
be determined based on average total consolidated assets as of the 
beginning of the first quarter of 2017.
---------------------------------------------------------------------------

    \47\ As discussed below, the proposed rule includes baseline 
requirements for all covered institutions and additional 
requirements for Level 1 and Level 2 covered institutions, which are 
larger covered institutions.
---------------------------------------------------------------------------

    The Agencies recognize that most incentive-based compensation plans 
are implemented at the beginning of the fiscal or calendar year. 
Depending on the date of publication of a final rule, the proposed 
compliance date would provide at least 18 months, and in most cases 
more than two years, for covered institutions to develop and approve 
new incentive-based compensation plans and 18 months for covered 
institutions to develop and implement the supporting policies, 
procedures, risk management framework, and governance that would be 
required under the proposed rule.
    1.1. The Agencies invite comment on whether this timing would be 
sufficient to allow covered institutions to implement any changes 
necessary for compliance with the proposed rule, particularly the 
development and implementation of policies and procedures. Is the 
length of time too long or too short and why? What specific changes 
would be required to bring existing policies and procedures into 
compliance with the rule? What constraints exist on the ability of 
covered institutions to meet the proposed deadline?
    1.2. The Agencies invite comment on whether the compliance date 
should instead be the beginning of the first performance period that 
starts at least 365 days after the final rule is published in the 
Federal Register in order to have the proposed rule's policies, 
procedures, risk management, and governance requirements begin when the 
requirements applicable to incentive-compensation plans and 
arrangements begin. Why or why not?
    Section __.1 also specifies that the proposed rule is not intended 
to limit the authority of any Agency under other provisions of 
applicable law and regulations. For example, the proposed rule would 
not affect the Federal Banking Agencies' authority under section 39 of 
the FDIA and the Federal Banking Agency Safety and Soundness 
Guidelines. The Board's Enhanced Prudential Standards under 12 CFR part 
252 (Regulation YY) would not be affected. The OCC's Heightened 
Standards also would continue to be in effect. The NCUA's authority 
under 12 U.S.C. 1761a, 12 CFR 701.2, part 701 App. A, Art. VII. section 
8, 701.21(c)(8)(i), 701.23(g) (1), 701.33, 702.203, 702.204, 703.17, 
704.19, 704.20, part 708a, 712.8, 721.7, and part 750, and the NCUA 
Examiners Guide, Chapter 7,\48\ would not be affected. Neither would 
the proposed rule affect the applicability of FHFA's executive 
compensation rule, under section 1318 of the Safety and Soundness Act 
(12 U.S.C. 4518), 12 CFR part 1230.
---------------------------------------------------------------------------

    \48\ The NCUA Examiners Guide, Chapter 7, available at https://www.ncua.gov/Legal/GuidesEtc/ExaminerGuide/Chapter07.pdf.
---------------------------------------------------------------------------

    The Agencies acknowledge that some individuals who would be 
considered covered persons, senior executive officers, or significant 
risk-takers under the proposed rule are subject to other Federal 
compensation-related requirements. Further, some covered institutions 
may be subject to SEC rules regarding the disclosure of executive 
compensation,\49\ and mortgage loan originators are subject to the 
Consumer Financial Protection Bureau's restrictions on compensation. 
This rule is not intended to affect the application of these other 
Federal compensation-related requirements.
---------------------------------------------------------------------------

    \49\ See Item 402 of Regulation S-K. 17 CFR 229.402.
---------------------------------------------------------------------------

Sec.  __.2 Definitions

    Section __.2 defines the various terms used in the proposed rule. 
Where the proposed rule uses a term defined in section 956, the 
proposed rule generally adopts the definition included in section 
956.\50\
---------------------------------------------------------------------------

    \50\ The definitions in the proposed rule would be for purposes 
of administering section 956 and would not affect the interpretation 
or construction of the same or similar terms for purposes of any 
other statute or regulation administered by the Agencies.
---------------------------------------------------------------------------

Definitions Pertaining to Covered Institutions
    Section 956(e)(2) of the Dodd-Frank Act defines the term ``covered 
financial institution'' to mean a depository institution; a depository 
institution holding company; a registered broker-dealer; a credit 
union; an investment adviser; the Federal National Mortgage Association 
(``Fannie Mae'') and the Federal Home Loan Mortgage Corporation 
(``Freddie Mac'') (together, the ``Enterprises''); and any other 
financial institution that the Agencies determine, jointly, by rule, 
should be treated as a covered financial institution for purposes of 
section 956. Section 956(f) provides that the requirements of section 
956 do not apply to covered financial institutions with assets of less 
than $1 billion.
    The Agencies propose to jointly, by rule, designate additional 
financial institutions as covered institutions. The Agencies propose to 
include the Federal Home Loan Banks as covered institutions because 
they pose risks similar to those of some institutions covered under the 
proposed rule and should be subject to the same regulatory regime. The 
Agencies also propose to include as covered institutions the state-
licensed uninsured branches and agencies of a foreign bank, 
organizations operating under section 25 or 25A of the Federal Reserve 
Act (i.e., Edge and Agreement Corporations), as well as the other U.S. 
operations of foreign banking organizations that are treated as bank 
holding companies pursuant to section 8(a) of the International Banking 
Act of 1978 (12 U.S.C. 3106). Applying the same requirements to these 
institutions would be consistent with other regulatory requirements 
that are applicable to foreign banking organizations operating in the 
United States and would not distort competition for human resources 
between U.S. banking organizations and foreign banking organizations 
operating in the United States. These offices and operations currently 
are referenced in the Federal Banking Agency Guidance and are subject 
to section 8 of the FDIA (12 U.S.C. 1818), which prohibits institutions 
from engaging in unsafe or unsound practices to the same extent as 
insured depository institutions and bank holding companies.\51\
---------------------------------------------------------------------------

    \51\ See 12 U.S.C. 1813(c)(3) and 1818(b)(4).
---------------------------------------------------------------------------

    In addition, the Agencies propose to jointly, by rule, designate 
state-chartered non-depository trust companies that are members of the 
Federal Reserve System as covered institutions. The definition of 
``covered financial institution'' under section 956 of the Dodd-Frank 
Act includes a depository institution as such term is defined in 
section 3 of the FDIA (12 U.S.C. 1813); that term includes all national 
banks and any state banks, including trust companies, that are engaged 
in the business of receiving deposits other than trust funds. As a 
consequence of these definitions, all

[[Page 37684]]

national banks, including national banks that are non-depository trust 
companies, are ``depository institutions'' within the meaning of 
section 956, but non-FDIC insured state non-depository trust companies 
that are members of the Federal Reserve System are not. In order to 
achieve equal treatment across similar entities with different 
charters, the Agencies propose to include state-chartered non-
depository member trust companies as covered institutions. These 
institutions would be ``regulated institutions'' under the definition 
of ``state member bank'' in the Board's rule.
    Each Agency's proposed rule contains a definition of the term 
``covered institution'' that describes the covered financial 
institutions the Agency regulates.
    The Agencies have tailored the requirements of the proposed rule to 
the size and complexity of covered institutions, and are proposing to 
designate covered institutions as Level 1, Level 2, or Level 3 covered 
institutions to effectuate this tailoring. The Agencies have observed 
through their supervisory experience that large financial institutions 
typically have complex business activities in multiple lines of 
business, distinct subsidiaries, and regulatory jurisdictions, and 
frequently operate and manage their businesses in ways that cross those 
lines of business, subsidiaries, and jurisdictions. Level 3 covered 
institutions would generally be subject to only the basic set of 
prohibitions and disclosure requirements. The proposed rule would apply 
additional prohibitions and requirements to incentive-based 
compensation arrangements at Level 1 and Level 2 covered institutions, 
as discussed below. Whether a covered institution that is a subsidiary 
of a depository institution holding company is a Level 1, Level 2, or 
Level 3 covered institution would be based on the average total 
consolidated assets of the top-tier depository institution holding 
company. Whether that subsidiary has at least $1 billion will be based 
on the subsidiary's average total consolidated assets.
    The Agency definitions of covered institution, Level 1, Level 2, 
and Level 3 covered institution, and related terms are summarized 
below.
    Covered Institution and Regulated Institution. Each Agency has set 
forth text for its Agency-specific definition of the term ``covered 
institution'' that specifies the entities to which that Agency's rule 
applies.\52\ Under the proposed rule, a ``covered institution'' would 
include all of the following:
---------------------------------------------------------------------------

    \52\ The Agency-specific definitions are intended to be applied 
only for purposes of administering a final rule under section 956.
---------------------------------------------------------------------------

     In the case of the OCC:
    [cir] A national bank, Federal savings association, or Federal 
branch or agency of a foreign bank \53\ with average total consolidated 
assets greater than or equal to $1 billion; and
---------------------------------------------------------------------------

    \53\ The term ``Federal branch or agency of a foreign bank'' 
refers to both insured and uninsured Federal branches and agencies 
of foreign banks.
---------------------------------------------------------------------------

    [cir] A subsidiary of a national bank, Federal savings association, 
or Federal branch or agency of a foreign bank, if the subsidiary (A) is 
not a broker, dealer, person providing insurance, investment company, 
or investment adviser; and (B) has average total consolidated assets 
greater than or equal to $1 billion.
     In the case of the Board, the proposed definition of the 
term ``covered institution'' is a ``regulated institution'' with 
average total consolidated assets greater than or equal to $1 billion, 
and the Board's definition of the term ``regulated institution'' 
includes:
    [cir] A state member bank, as defined in 12 CFR 208.2(g);
    [cir] A bank holding company, as defined in 12 CFR 225.2(c), that 
is not a foreign banking organization, as defined in 12 CFR 211.21(o), 
and a subsidiary of such a bank holding company that is not a 
depository institution, broker-dealer or investment adviser;
    [cir] A savings and loan holding company, as defined in 12 CFR 
238.2(m), and a subsidiary of a savings and loan holding company that 
is not a depository institution, broker-dealer or investment adviser;
    [cir] An organization operating under section 25 or 25A of the 
Federal Reserve Act (Edge and Agreement Corporation);
    [cir] A state-licensed uninsured branch or agency of a foreign 
bank, as defined in section 3 of the FDIA (12 U.S.C. 1813); and
    [cir] The U.S. operations of a foreign banking organization, as 
defined in 12 CFR 211.21(o), and a U.S. subsidiary of such foreign 
banking organization that is not a depository institution, broker-
dealer, or investment adviser.
     In the case of the FDIC, ``covered institution'' means a:
    [cir] State nonmember bank, state savings association, and a state 
insured branch of a foreign bank, as such terms are defined in section 
3 of the FDIA, 12 U.S.C. 1813, with average total consolidated assets 
greater than or equal to $1 billion; and
    [cir] A subsidiary of a state nonmember bank, state savings 
association, or a state insured branch of a foreign bank, as such terms 
are defined in section 3 of the FDIA, 12 U.S.C. 1813, that: (i) Is not 
a broker, dealer, person providing insurance, investment company, or 
investment adviser; and (ii) Has average total consolidated assets 
greater than or equal to $1 billion.
     In the case of the NCUA, a credit union, as described in 
section 19(b)(1)(A)(iv) of the Federal Reserve Act, meaning an insured 
credit union as defined under 12 U.S.C. 1752(7) or credit union 
eligible to make application to become an insured credit union under 12 
U.S.C. 1781. Instead of the term ``covered financial institution,'' the 
NCUA uses the term ``credit union'' throughout its proposed rule, as 
credit unions are the only type of covered institution NCUA regulates. 
The scope section of the rule defines the credit unions that will be 
subject to this rule--that is, credit unions with $1 billion or more in 
total consolidated assets.
     In the case of the SEC, a broker or dealer registered 
under section 15 of the Securities Exchange Act of 1934, 15 U.S.C. 78o; 
and an investment adviser, as such term is defined in section 
202(a)(11) of the Investment Advisers Act of 1940, 15 U.S.C. 80b-
2(a)(11).\54\ The proposed rule would not apply to persons excluded 
from the definition of investment adviser contained in section 
202(a)(11) of the Investment Advisers Act nor would it apply to such 
other persons not within the intent of section 202(a)(11) of the 
Investment Advisers Act, as the SEC may designate by rules and 
regulations or order. Section 956 does not contain exceptions or 
exemptions for investment advisers based on registration.\55\
---------------------------------------------------------------------------

    \54\ By its terms, the definition of ``covered financial 
institution'' in section 956 includes any institution that meets the 
definition of ``investment adviser'' under the Investment Advisers 
Act of 1940 (``Investment Advisers Act''), regardless of whether the 
institution is registered as an investment adviser under that Act. 
Banks and bank holding companies are generally excluded from the 
definition of ``investment adviser'' under section 202(a)(11) of the 
Investment Advisers Act, although they would still be ``covered 
institutions'' under the relevant Agency's proposed rule.
    \55\ Commenters to the 2011 Proposed Rule requested 
clarification with respect to those entities that are excluded from 
the definition of ``investment adviser'' under the Investment 
Advisers Act and those that are exempt from registration as an 
investment adviser under the Investment Advisers Act. Section 956 
expressly includes any institution that meets the definition of 
investment adviser regardless of whether the institution is 
registered under the Investment Advisers Act. See supra note 54. 
Thus, the proposed rule would apply to institutions that meet the 
definition of investment adviser under section 202(a)(11) of the 
Investment Advisers Act and would not exempt any such institutions 
that may be prohibited or exempted from registering with the SEC 
under the Investment Advisers Act.

---------------------------------------------------------------------------

[[Page 37685]]

     In the case of FHFA, the proposed definition of the term 
``covered institution'' is a ``regulated institution'' with average 
total consolidated assets greater than or equal to $1 billion, and 
FHFA's definition of the term ``regulated institution'' means an 
Enterprise, as defined in 12 U.S.C. 4502(10), and a Federal Home Loan 
Bank.
    Level 1, Level 2, and Level 3 covered institutions. The Agencies 
have tailored the requirements of the proposed rule to the size and 
complexity of covered institutions. All covered institutions would be 
subject to a basic set of prohibitions and disclosure requirements, as 
described in section __.4 of the proposed rule.
    The Agencies are proposing to group covered institutions into three 
levels. The first level, Level 1 covered institutions, would generally 
be covered institutions with average total consolidated assets of 
greater than $250 billion and subsidiaries of such institutions that 
are covered institutions. The next level, Level 2 covered institutions, 
would generally be covered institutions with average total consolidated 
assets between $50 billion and $250 billion and subsidiaries of such 
institutions that are covered institutions. The smallest covered 
institutions, those with average total consolidated assets between $1 
and $50 billion, would be Level 3 covered institutions and generally 
would be subject to only the basic set of prohibitions and 
requirements.\56\
---------------------------------------------------------------------------

    \56\ As discussed later in this Supplemental Information 
section, under section __.6 of the proposed rule, an Agency would be 
able to require a covered institution with average total 
consolidated assets greater than or equal to $10 billion and less 
than $50 billion to comply with some or all of the provisions of 
section __.5 and sections __.7 through__.11, if the Agency 
determines that the activities, complexity of operations, risk 
profile, or compensation practices of the covered institution are 
consistent with those of a Level 1 or Level 2 covered institution.
---------------------------------------------------------------------------

    The proposed rule would apply additional prohibitions and 
requirements to incentive-based compensation arrangements at Level 1 
and Level 2 covered institutions, as described in section __.5 and 
sections __.7 through __.11 of the proposed rule and further discussed 
below. The specific requirements of the proposed rule that would apply 
to Level 1 and Level 2 covered institutions are the same, with the 
exception of the deferral amounts and deferral periods described in 
section __.7(a)(1) and section __.7(a)(2).
Consolidation
    Generally, the Agencies also propose that covered institutions that 
are subsidiaries of other covered institutions would be subject to the 
same requirements, and defined to be the same level, as the parent 
covered institution,\57\ even if the subsidiary covered institution is 
smaller than the parent covered institution.\58\ This approach of 
assessing risks at the level of the holding company for a consolidated 
organization recognizes that financial stress or the improper 
management of risk in one part of an organization has the potential to 
spread rapidly to other parts of the organization. Large depository 
institution holding companies increasingly operate and manage their 
businesses in such a way that risks affect different subsidiaries 
within the consolidated organization and are managed on a consolidated 
basis. For example, decisions about business lines including management 
and resource allocation may be made by executives and employees in 
different subsidiaries. Integrating products and operations may offer 
significant efficiencies but can also result in financial stress or the 
improper management of risk in one part of a consolidated organization 
and has the potential to spread risk rapidly to other parts of the 
consolidated organization. Even when risk is assessed at the level of 
the holding company, risk will also be assessed at individual 
institutions within that consolidated organization. For example, a bank 
subsidiary of a large, complex bank holding company might have a 
different risk profile than the bank holding company. In that 
situation, a risk assessment would have different results when 
conducted at the level of the bank and at the level of the bank holding 
company.
---------------------------------------------------------------------------

    \57\ Commenters on the 2011 Proposed Rule questioned how the 
requirements would apply in the context of consolidated 
organizations where a parent holding company structure may include 
one or more subsidiary banks, broker-dealers, or investment advisers 
each with total consolidated assets either above or below, or 
somewhere in between, the relevant thresholds. They also expressed 
concern that the 2011 Proposed Rule could lead to ``regulatory 
overlap'' where the parent holding company and individual 
subsidiaries are regulated by different agencies.
    \58\ For the U.S. operations of a foreign banking organization, 
level would be determined by the total consolidated U.S. assets of 
the foreign banking organization, including the assets of any U.S. 
branches or agencies of the foreign banking organization, any U.S. 
subsidiaries of the foreign banking organization, and any U.S. 
operations held pursuant to section 2(h)(2) of the Bank Holding 
Company Act. In contrast, the level of an OCC-regulated Federal 
branch or agency of a foreign bank would be determined with 
reference to the assets of the Federal branch or agency. This 
treatment is consistent with the determination of the level of a 
national bank or Federal savings association that is not a 
subsidiary of a holding company and the OCC's approach to regulation 
of Federal branches and agencies.
---------------------------------------------------------------------------

    Moreover, in the experience of the Federal Banking Agencies, 
incentive-based compensation programs generally are designed at the 
holding company level and are applied throughout the consolidated 
organization. Many holding companies establish incentive-based 
compensation programs in this manner because it can help maintain 
effective risk management and controls for the entire consolidated 
organization. More broadly, the expectations and incentives established 
by the highest levels of corporate leadership set the tone for the 
entire organization and are important factors of whether an 
organization is capable of maintaining fully effective risk management 
and internal control processes. The Board has observed that some large, 
complex depository institution holding companies have evolved toward 
comprehensive, consolidated risk management to measure and assess the 
range of their exposures and the way these exposures interrelate, 
including in the context of incentive-based compensation programs. In 
supervising the activities of depository institution holding companies, 
the Board has adopted and continues to follow the principle that 
depository institution holding companies should serve as a source of 
financial and managerial strength for their subsidiary depository 
institutions.\59\
---------------------------------------------------------------------------

    \59\ See 12 U.S.C. 1831o-1; 12 CFR 225.4(a)(1).
---------------------------------------------------------------------------

    The proposed rule is designed to reinforce the ability of 
institutions to establish and maintain effective risk management and 
controls for the entire consolidated organization with respect to the 
organization's incentive-based compensation program. Moreover, the 
structure of the proposed rule is also consistent with the reality that 
within many large depository institution holding companies, covered 
persons may be employed by one legal entity but may do work for one or 
more of that entity's affiliates. For example, an employee of a 
national bank might also perform certain responsibilities on behalf of 
an affiliated broker-dealer. Applying the same requirements to all 
subsidiary covered institutions may reduce the possibility of evasion 
of the more specific standards applicable to certain individuals at 
Level 1 or Level 2 covered institutions. Finally, this approach may 
enable holding company structures to more effectively manage

[[Page 37686]]

human resources, because applying the same requirements to all 
subsidiary covered institutions would treat similarly the incentive-
based compensation arrangements for similar positions at different 
subsidiaries within a holding company structure.\60\
---------------------------------------------------------------------------

    \60\ For example, requirements that apply to certain job 
functions in one part of a consolidated organization but not to the 
same job function in another operating unit of the same holding 
company structure could create uneven treatment across the legal 
entities.
---------------------------------------------------------------------------

    The proposed rule would also be consistent with the requirements of 
overseas regulators who have examined the role that incentive-based 
compensation plays in institutions. After examining the risks posed by 
certain incentive-based compensation programs, many foreign regulators 
are now requiring that the rules governing incentive-based compensation 
be applied at the group, parent, and subsidiary operating levels 
(including those in offshore financial centers).\61\
---------------------------------------------------------------------------

    \61\ See, e.g., Article 92 of the CRD IV (2013/36/EU).
---------------------------------------------------------------------------

    The Agencies are cognizant that the approach being proposed may 
have some disadvantages for smaller subsidiaries within a larger 
depository institution holding company structure by applying the more 
specific provisions of the proposed rule to these smaller institutions 
that would not otherwise apply to them but for being a subsidiary of a 
depository institution holding company. As further discussed below, in 
an effort to reduce burden, the Board's proposed rule would permit 
institutions that are subsidiaries of depository institution holding 
companies and that are subject to the Board's proposed rule to meet the 
requirements of the proposed rule if the parent covered institution 
complies with the requirements in such a way that causes the relevant 
portion of the incentive-based compensation program of the subsidiary 
covered institution to comply with the requirements.\62\
---------------------------------------------------------------------------

    \62\ See section __.3(c) of the proposed rule.
---------------------------------------------------------------------------

    Similarly, the OCC's proposed rule would allow a covered 
institution subject to the OCC's proposed rule that is a subsidiary of 
another covered institution subject to the OCC's proposed rule to meet 
a requirement of the OCC's proposed rule if the parent covered 
institution complies with that requirement in a way that causes the 
relevant portion of the incentive-based compensation program of the 
subsidiary covered institution to comply with that requirement.
    The FDIC's proposed rule would similarly allow a covered 
institution subject to the FDIC's proposed rule that is a subsidiary of 
another covered institution subject to the FDIC's proposed rule to meet 
a requirement of the FDIC's proposed rule if the parent covered 
institution complies with that requirement in a way that causes the 
relevant portion of the incentive-based compensation program of the 
subsidiary covered institution to comply with that requirement.
    The SEC is not proposing to require a covered institution under its 
proposed rule that is a subsidiary of another covered institution under 
that proposed rule to be subject to the same requirements, and defined 
to be the same levels, as the parent covered institution. In general, 
the operations, services, and products of broker-dealers and 
investments advisers are not typically effected through subsidiaries 
\63\ and it is expected that their incentive-based compensation 
arrangements are typically derived from the activities of the broker-
dealers and investment advisers themselves. Because of this, any 
inappropriate risks for which the incentive-based compensation programs 
at these firms may encourage should be localized, and the management of 
these risks similarly should reside at the broker-dealer or investment 
adviser. Where that is not the case, individuals that are employed by 
subsidiaries of a broker-dealer or investment adviser may still be 
considered to be a ``significant risk-taker'' for the covered 
institution and, therefore, subject to the proposed rule.\64\ In 
addition, broker-dealers and investment advisers that are subsidiaries 
of depository institution holding companies would be consolidated on 
the basis of such depository institution holding companies generally, 
where there is often a greater integration of products and operations, 
public interest, and assessment and management of risk (including those 
related to incentive-based compensation) across the depository 
institution holding companies and their subsidiaries.\65\
---------------------------------------------------------------------------

    \63\ In addition, the SEC's regulatory regime with respect to 
broker-dealers and investment advisers generally applies on an 
entity-by-entity basis. For example, subject to certain exclusions, 
any person that for compensation is engaged in the business of 
providing advice, making recommendations, issuing reports, or 
furnishing analyses on securities, either directly or through 
publications is subject to the Investment Advisers Act. See 15 
U.S.C. 80b-2(a)(11).
    \64\ The proposed rule also prohibits a covered institution from 
doing indirectly, or through or by any other person, anything that 
would be unlawful for such covered institution to do directly. See 
section 303.12. For example, the SEC has stated that it will, based 
on facts and circumstances, treat as a single investment adviser two 
or more affiliated investment advisers that are separate legal 
entities but are operationally integrated. See Exemptions for 
Advisers to Venture Capital Funds, Private Fund Advisers With Less 
Than $150 Million in Assets Under Management, and Foreign Private 
Advisers, Investment Advisers Act Release No. 3222 (June 22, 2011) 
76 FR 39,646 (July 6, 2011); In the Matter of TL Ventures, Inc., 
Investment Advisers Act Release No. 3859 (June 20, 2014) (settled 
action); section 15 U.S.C. 80b-8.
    \65\ As discussed above in this Supplementary Information, the 
Agencies propose that covered institutions that are subsidiaries of 
covered institutions that are depository institution holding 
companies would be subject to the same requirements, and defined to 
be the same level, as the parent covered institutions. Because the 
failure of a depository institution may cause losses to the deposit 
insurance fund, there is a heightened interest in the safety and 
soundness of depository institutions and their holding companies. 
Moreover, as noted above, depository institution holding companies 
should serve as a source of financial and managerial strength for 
their subsidiary depository institutions. Additionally, in the 
experience of the Federal Banking Agencies, incentive-based 
compensation programs generally are designed at the holding company 
level and are applied throughout the consolidated organization. The 
Board has observed that complex depository institution holding 
companies have evolved toward comprehensive, consolidated risk 
management to measure and assess the range of their exposures and 
the way these exposures interrelate, including in the context of 
incentive-based compensation programs.
---------------------------------------------------------------------------

Level 1, Level 2, and Level 3 Covered Institutions
    For purposes of the proposed rule, the Agencies have specified the 
three levels of covered institutions as:
     In the case of the OCC:
    [cir] A ``Level 1 covered institution'' means: (i) A covered 
institution that is a subsidiary of a depository institution holding 
company with average total consolidated assets greater than or equal to 
$250 billion; (ii) a covered institution with average total 
consolidated assets greater than or equal to $250 billion that is not a 
subsidiary of a covered institution or of a depository institution 
holding company; and (iii) a covered institution that is a subsidiary 
of a covered institution with average total consolidated assets greater 
than or equal to $250 billion.
    [cir] A ``Level 2 covered institution'' means: (i) A covered 
institution that is a subsidiary of a depository institution holding 
company with average total consolidated assets greater than or equal to 
$50 billion but less than $250 billion; (ii) a covered institution with 
average total consolidated assets greater than or equal to $50 billion 
but less than $250 billion that is not a subsidiary of a covered 
institution or of a depository institution holding company; and (iii) a 
covered institution that is a subsidiary of a covered institution with 
average total consolidated assets greater than or equal to $50 billion 
but less than $250 billion.
    [cir] A ``Level 3 covered institution'' means: (i) A covered 
institution with average total consolidated assets greater

[[Page 37687]]

than or equal to $1 billion but less than $50 billion; and (ii) a 
covered institution that is a subsidiary of a covered institution with 
average total consolidated assets greater than or equal to $1 billion 
but less than $50 billion.
     In the case of the Board:
    [cir] A ``Level 1 covered institution'' means a covered institution 
with average total consolidated assets greater than or equal to $250 
billion and any subsidiary of a Level 1 covered institution that is a 
covered institution.
    [cir] A ``Level 2 covered institution'' means a covered institution 
with average total consolidated assets greater than or equal to $50 
billion that is not a Level 1 covered institution and any subsidiary of 
a Level 2 covered institution that is a covered institution.
    [cir] A ``Level 3 covered institution'' means a covered institution 
with average total consolidated assets greater than or equal to $1 
billion that is not a Level 1 or Level 2 covered institution.
     In the case of the FDIC:
    [cir] A ``Level 1 covered institution'' means: (i) A covered 
institution that is a subsidiary of a depository institution holding 
company with average total consolidated assets greater than or equal to 
$250 billion; (ii) a covered institution with average total 
consolidated assets greater than or equal to $250 billion that is not a 
subsidiary of a depository institution holding company; and (iii) a 
covered institution that is a subsidiary of a covered institution with 
average total consolidated assets greater than or equal to $250 
billion.
    [cir] A ``Level 2 covered institution'' means: (i) A covered 
institution that is a subsidiary of a depository institution holding 
company with average total consolidated assets greater than or equal to 
$50 billion but less than $250 billion; (ii) a covered institution with 
average total consolidated assets greater than or equal to $50 billion 
but less than $250 billion that is not a subsidiary of a depository 
institution holding company; and (iii) a covered institution that is a 
subsidiary of a covered institution with average total consolidated 
assets greater than or equal to $50 billion but less than $250 billion.
    [cir] A ``Level 3 covered institution'' means: (i) A covered 
institution that is a subsidiary of a depository institution holding 
company with average total consolidated assets greater than or equal to 
$1 billion but less than $50 billion; (ii) a covered institution with 
average total consolidated assets greater than or equal to $1 billion 
but less than $50 billion that is not a subsidiary of a depository 
institution holding company; and (iii) a covered institution that is a 
subsidiary of a covered institution with average total consolidated 
assets greater than or equal to $1 billion but less than $50 billion.
     In the case of the NCUA:
    [cir] A ``Level 1 credit union'' means a credit union with average 
total consolidated assets of $250 billion or more.
    [cir] A ``Level 2 credit union'' means a credit union with average 
total consolidated assets greater than or equal to $50 billion that is 
not a Level 1 credit union.
    [cir] A ``Level 3 credit union'' means a credit union with average 
total consolidated assets greater than or equal to $1 billion that is 
not a Level 1 or Level 2 credit union.
     In the case of the SEC:
    [cir] A ``Level 1 covered institution'' means: (i) A covered 
institution with average total consolidated assets greater than or 
equal to $250 billion; or (ii) a covered institution that is a 
subsidiary of a depository institution holding company that is a Level 
1 covered institution pursuant to 12 CFR 236.2.
    [cir] A ``Level 2 covered institution'' means: (i) A covered 
institution with average total consolidated assets greater than or 
equal to $50 billion that is not a Level 1 covered institution; or (ii) 
a covered institution that is a subsidiary of a depository institution 
holding company that is a Level 2 covered institution pursuant to 12 
CFR 236.2.
    [cir] A ``Level 3 covered institution'' means a covered institution 
with average total consolidated assets greater than or equal to $1 
billion that is not a Level 1 covered institution or Level 2 covered 
institution.
     In the case of FHFA:
    [cir] A ``Level 1 covered institution'' means a covered institution 
with average total consolidated assets greater than or equal to $250 
billion that is not a Federal Home Loan Bank.
    [cir] A ``Level 2 covered institution'' means a covered institution 
with average total consolidated assets greater than or equal to $50 
billion that is not a Level 1 covered institution and any Federal Home 
Loan Bank that is a covered institution.
    [cir] A ``Level 3 covered institution'' means a covered institution 
with average total consolidated assets greater than or equal to $1 
billion that is not a Level 1 covered institution or Level 2 covered 
institution.
    The Agencies considered the varying levels of complexity and risks 
across covered institutions that would be subject to this proposed 
rule, as well as the general correlation of asset size with those 
potential risks, in proposing to distinguish covered institutions by 
their asset size.\66\ In general, larger financial institutions have 
more complex structures and operations. These more complex structures 
make controlling risk-taking more difficult. Moreover, these larger, 
more complex institutions also tend to be significant users of 
incentive-based compensation. Significant use of incentive-based 
compensation combined with more complex business operations can make it 
more difficult to immediately recognize and assess risks for the 
institution as a whole. Therefore, the requirements of the proposed 
rule are tailored to reflect the size and complexity of each of the 
three levels of covered institutions identified in the proposed rule. 
The proposed rule assigns covered institutions to one of three levels, 
based on each institution's average total consolidated assets.
---------------------------------------------------------------------------

    \66\ But see earlier discussion regarding consolidation.
---------------------------------------------------------------------------

    Additionally, the Agencies considered the exemption in section 956 
for institutions with less than $1 billion in assets along with other 
asset-level thresholds in the Dodd-Frank Act \67\ as an indication that 
Congress views asset size as an appropriate basis for the requirements 
and prohibitions established under this proposed rule. Consistent with 
this approach, the Agencies also looked to asset size to determine the 
types of prohibitions that would be necessary to discourage 
inappropriate risks at covered institutions that could lead to material 
financial loss.
---------------------------------------------------------------------------

    \67\  See, e.g., section 116 of the Dodd-Frank Act (12 U.S.C. 
5326) (allowing the Financial Stability Oversight Council to require 
a bank holding company with total consolidated assets of $50 billion 
or more to submit reports); section 163 of the Dodd-Frank Act (12 
U.S.C. 5363) (requiring prior notice to the Board for certain 
acquisitions by bank holding companies with total consolidated 
assets of $50 billion or more); section 165 of the Dodd-Frank Act 
(12 U.S.C. 5365) (requiring enhanced prudential standards for bank 
holding companies with total consolidated assets of $50 billion or 
more); section 318(c) of the Dodd-Frank Act (12 U.S.C. 16) 
(authorizing the Board to collect assessments, fees, and other 
charges from bank holding companies and savings and loan holding 
companies with total consolidated assets of $50 billion or more).
---------------------------------------------------------------------------

    The Agencies are proposing that more rigorous requirements apply to 
institutions with $50 billion or more in assets. These institutions 
with assets of $50 billion or more tend to be significantly more 
complex and, the risk-taking of these institutions, and their potential 
failure, implicates greater risks for the financial system and the 
overall economy. Tailoring application of the requirements of the 
proposed rule is consistent with other provisions of the Dodd-Frank 
Act, which distinguish requirements for institutions with $50

[[Page 37688]]

billion or more in total consolidated assets. For example, the enhanced 
supervision and prudential standards for nonbank financial companies 
and bank holding companies under section 165 \68\ apply to bank holding 
companies with total consolidated assets of $50 billion or greater. It 
is also consistent with the definitions of advanced approaches 
institutions under the Federal Banking Agencies' domestic capital 
rules,\69\ which are linked to the total consolidated assets of an 
institution. Other statutory and regulatory provisions recognize this 
difference.\70\
---------------------------------------------------------------------------

    \68\ 12 U.S.C. 5365.
    \69\ See 12 CFR 3.100(b)(1) (advanced approaches national banks 
and Federal savings associations); 12 CFR 324.100(b)(1) (advanced 
approaches state nonmember banks, state savings associations, and 
insured branches of foreign banks); 12 CFR 217.100(b)(1) (advanced 
approaches bank holding companies, savings and loan holding 
companies, and state member banks).
    \70\ See, e.g., Board, ``Regulatory Capital Rules: 
Implementation of Risk-Based Capital Surcharges for Global 
Systemically Important Bank Holding Companies,'' 80 FR 49081 (August 
14, 2015); Board, ``Single-Counterparty Credit Limits for Large 
Banking Organizations; Proposed Rule,'' 81 FR 14327 (March 4, 2016); 
Board, ``Debit Card Interchange Fees and Routing; Final Rule,'' 76 
FR 43393 (July 20, 2011); Board, ``Supervision and Regulation 
Assessments for Bank Holding Companies and Savings and Loan Holding 
Companies With Total Consolidated Assets of $50 Billion or More and 
Nonbank Financial Companies Supervised by the Federal Reserve,'' 78 
FR 52391 (August 23, 2013); OCC, Board, FDIC, ``Supplementary 
Leverage Ratio; Final Rule,'' 79 FR 57725 (September 26, 2014).
---------------------------------------------------------------------------

    Most of the requirements of the proposed rule would apply to Level 
1 and Level 2 covered institutions in a similar manner. Deferral 
requirements, however, would be different for Level 1 and Level 2 
covered institutions, as discussed further below: Incentive-based 
compensation for senior executive officers and significant risk-takers 
at covered institutions with average total consolidated assets equal to 
or greater than $250 billion would be subject to a higher percentage of 
deferral, and longer deferral periods. In the experience of the 
Agencies, covered institutions with assets of $250 billion or more tend 
to be significantly more complex and thus exposed to a higher level of 
risk than those with assets of less than $250 billion. The risk-taking 
of these institutions, and their potential failure, implicates the 
greatest risks for the broader economy and financial system. Other 
statutory and regulatory provisions recognize this difference. For 
example, the definitions of advanced approaches institutions under the 
Federal Banking Agencies' domestic capital rules establish a $250 
billion threshold for coverage. This approach is similar to that used 
in the international standards published by the Basel Committee on 
Banking Supervision, and rules implementing such capital standards, 
under which banks with consolidated assets of $250 billion or more are 
subject to enhanced capital and leverage standards.
    As noted above, the Agencies propose to designate the Federal Home 
Loan Banks as covered institutions. Under FHFA's proposed rule, each 
Federal Home Loan Bank would be a Level 2 covered institution by 
definition, as opposed to by total consolidated assets. As long as a 
Federal Home Loan Bank is a covered institution under this part, with 
average total consolidated assets greater than or equal to $1 billion, 
it is a Level 2 covered institution. FHFA proposes this approach 
because generally for the Federal Home Loan Banks, asset size is not a 
meaningful indicator of risk. The Federal Home Loan Banks all operate 
in a similar enough manner that treating them differently based on 
asset size is not justifiable. Because of the scalability of the 
Federal Home Loan Bank business model, it is possible for a Federal 
Home Loan Bank to pass back and forth over the asset-size threshold 
without any meaningful change in risk profile. FHFA proposes to 
designate the Federal Home Loan Banks as Level 2 covered institutions 
instead of Level 3 covered institutions because at the time of the 
proposed rule, at least one Federal Home Loan Bank would be a Level 2 
covered institution if determined by asset size, and the regulatory 
requirements under the proposed rule that seem most appropriate for the 
Federal Home Loan Banks are those of Level 2 covered institutions.
    Similar to the approach used by the Federal Banking Agencies in 
their general supervision of banking organizations, if the proposed 
rule were adopted, the Agencies would generally expect to coordinate 
oversight and, to the extent applicable, supervision for consolidated 
organizations in order to assess compliance throughout the consolidated 
organization with any final rule. The Agencies are cognizant that 
effective and consistent supervision generally requires coordination 
among the Agencies that regulate the various entities within a 
consolidated organization. The supervisory authority of each 
appropriate Federal regulator to examine and review its covered 
institutions for compliance with the proposed rule would not be 
affected under this approach.
    Affiliate. For the OCC, the Board, the FDIC, and the SEC, the 
proposed rule would define ``affiliate'' to mean any company that 
controls, is controlled by, or is under common control with another 
company. FHFA's proposed rule would not include a definition of 
``affiliate.'' The Federal Home Loan Banks have no affiliates, and 
affiliates of the Enterprises are included as part of the definition of 
Enterprise in the Safety and Soundness Act, which is referenced in the 
definition of regulated entity. The NCUA's proposed rule also would not 
include a definition of ``affiliate.'' While in some cases, credit 
union service organizations (``CUSOs'') might be considered affiliates 
of a credit union, NCUA has determined that this rule would not apply 
to CUSOs.
    Average total consolidated assets. Consistent with section 956, the 
proposed rule would not apply to institutions with less than $1 billion 
in assets. Additionally, as discussed above, under the proposed rule, 
more specific requirements would apply to institutions with higher 
levels of assets. The Agencies propose to use average total 
consolidated assets to measure assets for the purposes of determining 
applicability of the requirements of this rule. Whether a covered 
institution that is a subsidiary of a depository institution holding 
company is a Level 1, Level 2, or Level 3 covered institution would be 
based on the average total consolidated assets of the top-tier 
depository institution holding company. Whether that subsidiary has at 
least $1 billion will be based on the subsidiary's average total 
consolidated assets.
    For an institution that is not an investment adviser, average total 
consolidated assets would be determined with reference to the average 
of the total consolidated assets reported on regulatory reports for the 
four most recent consecutive quarters. This method is consistent with 
those used to calculate total consolidated assets for purposes of other 
rules that have $50 billion thresholds,\71\ and it may reduce 
administrative burden on institutions--particularly Level 3 covered 
institutions that become Level 2 covered institutions--if average total 
consolidated assets are calculated in the same way for the proposed 
rule. For an institution that does not have a regulatory report for 
each of the four most recent consecutive quarters to reference, average 
total consolidated assets would mean the average of total consolidated 
assets, as reported on the relevant regulatory reports, for the most 
recent quarter or consecutive quarters available, as applicable. 
Average total

[[Page 37689]]

consolidated assets would be measured on the as-of date of the most 
recent regulatory report used in the calculation of the average. For a 
covered institution that is an investment adviser, average total 
consolidated assets would be determined by the investment adviser's 
total assets (exclusive of non-proprietary assets) shown on the balance 
sheet for the adviser's most recent fiscal year end.\72\
---------------------------------------------------------------------------

    \71\ See, e.g., OCC's Heightened Standards (12 CFR part 30, 
Appendix D); 12 CFR 46.3; 12 CFR 225.8; 12 CFR 243.2; 12 CFR 252.30; 
2 CFR 252.132; 12 CFR 325.202; 12 CFR 381.2.
    \72\ This proposed method of calculation for investment advisers 
corresponds to the reporting requirement in Item 1.O. of Part 1A of 
Form ADV, which currently requires an investment adviser to check a 
box to indicate if it has assets of $1 billion or more. See Form 
ADV, Part IA, Item 1.O.; SEC, ``Rules Implementing Amendments to the 
Investment Advisers Act of 1940, Investment Advisers Release No. IA-
3221,'' 76 FR 42950 (July 19, 2011). Many commenters to the first 
notice of proposed rulemaking indicated that they understood that 
the SEC did not intend ``total consolidated assets'' to include non-
proprietary assets, such as client assets under management; others 
requested clarification that this understanding is correct. The SEC 
is clarifying in the proposed rule that investment advisers should 
include only proprietary assets in the calculation--that is, non-
proprietary assets, such as client assets under management would not 
be included, regardless of whether they appear on an investment 
adviser's balance sheet. The SEC notes that this method is drawn 
directly from section 956. See section 956(f) (referencing 
``assets'' only).
---------------------------------------------------------------------------

    The Board's proposed rule would require that savings and loan 
holding companies that do not file a regulatory report within the 
meaning of section __.2(ee)(3) of the Board's proposed rule report 
their average total consolidated assets to the Board on a quarterly 
basis. In addition, foreign banking organizations with U.S. operations 
would be required to report their total consolidated U.S. assets to the 
Board on a quarterly basis. These regulated institutions would be 
required to report their average total consolidated assets to the Board 
either because they do not file reports of their total consolidated 
assets with the Board (in the case of savings and loan holding 
companies that do not file a regulatory report with the Board within 
the meaning of section __.2(ee)(3) of the Board's proposed rule), or 
because the reports filed do not encompass the full range of assets (in 
the case of foreign banking organizations with U.S. operations). Asset 
information concerning the U.S. operations of foreign banking 
organizations is filed on form FRY-7Q, but the information does not 
include U.S. assets held pursuant to section 2(h)(2) of the Bank 
Holding Company Act. Foreign banking organizations with U.S. operations 
would report their average total consolidated U.S. assets including 
assets held pursuant to section 2(h)(2) of the Bank Holding Company Act 
for purposes of complying with the requirements of section __.2(ee)(3) 
of the Board's proposed rule. The Board would propose that reporting 
forms be created or modified as necessary for these institutions to 
meet these reporting requirements.
    The proposed rule does not specify a method for determining the 
total consolidated assets of some types of subsidiaries that would be 
considered covered institutions under the proposed rule, because those 
subsidiaries do not currently submit regular reports of their asset 
size to the Agencies. For the subsidiary of a national bank, Federal 
savings association, or Federal branch or agency of a foreign bank, the 
OCC would rely on a report of the subsidiary's total consolidated 
assets prepared by the subsidiary, national bank, Federal savings 
association, or Federal branch or agency in a form that is acceptable 
to the OCC. Similarly, for a regulated institution subsidiary of a bank 
holding company, savings and loan holding company, or foreign banking 
organization the Board would rely on a report of the subsidiary's total 
consolidated assets prepared by the bank holding company or savings and 
loan holding company in a form that is acceptable to the Board.
    Control. The definition of control in the proposed rule is similar 
to the definition of the same term in the Bank Holding Company Act.\73\ 
Any company would have control over a bank or any company if: (1) The 
company directly or indirectly or acting through one or more other 
persons owns, controls, or has power to vote 25 percent or more of any 
class of voting securities of the bank or company; (2) the company 
controls in any manner the election of a majority of the directors or 
trustees of the bank or company; or (3) the appropriate Federal 
regulator determines, after notice and opportunity for hearing, that 
the company directly or indirectly exercises a controlling influence 
over the management or policies of the bank or company.
---------------------------------------------------------------------------

    \73\ 12 U.S.C. 1841(a)(2).
---------------------------------------------------------------------------

    Depository institution holding company. The OCC's, the FDIC's, and 
the SEC's proposed rules define ``depository institution holding 
company'' to mean a top-tier depository institution holding company, 
where ``depository institution holding company'' would have the same 
meaning as in section 3 of the FDIA.\74\ In a multi-tiered depository 
institution holding company, references in the OCC's, FDIC's and SEC's 
proposed rules to the ``depository institution holding company'' would 
mean the top-tier depository institution holding company of the multi-
tiered holding company only.
---------------------------------------------------------------------------

    \74\ See 12 U.S.C. 1813(w).
---------------------------------------------------------------------------

    For example, for the purpose of determining whether a state 
nonmember bank that is a subsidiary of a depository institution holding 
company and is within a multi-tiered depository institution holding 
company structure is a Level 1, Level 2, or Level 3 covered institution 
under the FDIC's proposed rule, the state nonmember would look to the 
top-tier depository institution holding company's average total 
consolidated assets. Thus, in a situation in which a state nonmember 
bank with average total consolidated assets of $35 billion is a 
subsidiary of a depository institution holding company with average 
total consolidated assets of $45 billion that is itself a subsidiary of 
a depository institution holding company with $75 billion in average 
total consolidated assets, the state nonmember bank would be treated as 
a Level 2 covered institution because the top-tier depository 
institution holding company has average total consolidated assets of 
$75 billion (which is greater than or equal to $50 billion but less 
than $250 billion). Similarly, state member banks and national banks 
within multi-tiered depository institution holding company structures 
would look to the top-tier depository institution holding company's 
average total consolidated assets when determining if they are a Level 
1, Level 2 or Level 3 covered institution under the Board's and the 
OCC's proposed rules.
    Subsidiary. For the OCC, the Board, the FDIC, and the SEC, the 
proposed rule would define ``subsidiary'' to mean any company which is 
owned or controlled directly or indirectly by another company. The 
Board proposes to exclude from its definition of ``subsidiary'' any 
merchant banking investment that is owned or controlled pursuant to 12 
U.S.C. 1843(k)(4)(H) and subpart J of the Board's Regulation Y (12 CFR 
part 225) and any company with respect to which the covered institution 
acquired ownership or control in the ordinary course of collecting a 
debt previously contracted in good faith. Depository institution 
holding companies may hold such investments only for limited periods of 
time by law. Application of the proposed rule to these institutions 
directly would not further the purpose of the proposed rule under 
section 956. The holding company and any nonbanking subsidiary holding 
these investments would be subject to the proposed rule. For these 
reasons, the Board is proposing to exclude from the definition

[[Page 37690]]

of subsidiary companies owned by a holding company as merchant banking 
investments or through debt previously contracted in good faith. These 
companies would, therefore, not be required to conform their incentive-
based compensation programs to the requirements of the proposed rule.
    FHFA's proposed rule would not include a definition of 
``subsidiary.'' The Federal Home Loan Banks have no subsidiaries, and 
any subsidiaries of the Enterprises as defined by other Agencies under 
the proposed rule would be included as affiliates as part of the 
definition of Enterprise in the Safety and Soundness Act, which is 
referenced in the definition of regulated entity. The NCUA's proposed 
rule also would not include a definition of ``subsidiary.'' While in 
some cases, CUSOs might be considered subsidiaries of a credit union, 
NCUA has determined that this rule would not apply to CUSOs.
    2.1. The Agencies invite comment on whether other financial 
institutions should be included in the definition of ``covered 
institution'' and why.
    2.2. The Agencies invite comment on whether any additional 
financial institutions should be included in the proposed rule's 
definition of subsidiary and why.
    2.3. The Agencies invite comment on whether any additional 
financial institutions (such as registered investment companies) should 
be excluded from the proposed rule's definition of subsidiary and why.
    2.4. The Agencies invite comment on the definition of average total 
consolidated assets.
    2.5. The Agencies invite comment on the proposed rule's approach to 
consolidation. Are there any additional advantages to the approach? For 
example, the Agencies invite comment on the advantages of the proposed 
rule's approach for reinforcing the ability of an institution to 
establish and maintain effective risk management and controls for the 
entire consolidated organization and enabling holding company 
structures to more effectively manage human resources. Are there 
advantages to the approach of the proposed rule in helping to reduce 
the possibility of evasion of the more specific standards applicable to 
certain individuals at Level 1 or Level 2 covered institutions? Are 
there any disadvantages to the proposed rule's approach to 
consolidation? For example, the Agencies invite comment on any 
disadvantages smaller subsidiaries of a larger covered institution may 
have by applying the more specific provisions of the proposed rule to 
these smaller institutions that would not otherwise apply to them but 
for being a subsidiary of a larger institution. Is there another 
approach that the proposed rule should take? The Agencies invite 
comment on any advantages and disadvantages of the SEC's proposal to 
not consolidate subsidiaries of broker-dealers and investment advisers 
that are not themselves subsidiaries of depository institution holding 
companies. Are the operations, services, and products of broker-dealers 
and investment advisers not typically effected through subsidiaries? 
Should the SEC adopt an express requirement to treat two or more 
affiliated investment advisers or broker-dealers that are separate 
legal entities (e.g., investment advisers that are operationally 
integrated) as a single investment adviser or broker-dealer for 
purposes of the proposed rule's thresholds?
    2.6. The Agencies invite comment on whether the three-level 
structure would be a workable approach for categorizing covered 
institutions by asset size and why.
    2.7. The Agencies invite comment on whether the asset thresholds 
used in these definitions would divide covered institutions into 
appropriate groups based on how they view the competitive marketplace. 
If asset thresholds are not the appropriate methodology for determining 
which requirements apply, which other alternative methodologies would 
be appropriate and why?
    2.8. Are there instances where it may be appropriate to modify the 
requirements of the proposed rule where there are multiple covered 
institutions subsidiaries within a single parent organization based 
upon the relative size, complexity, risk profile, or business model, 
and use of incentive-based compensation of the covered institution 
subsidiaries within the consolidated organization? In what situations 
would that be appropriate and why?
    2.9. Is the Agencies' assumption that incentive-based compensation 
programs are generally designed and administered at the holding company 
level for the organization as a whole correct? Why or why not? To what 
extent do broker-dealers or investment advisers within a holding 
company structure apply the same compensation standards as other 
subsidiaries in the parent company?
    2.10. Bearing in mind that section 956 by its terms seeks to 
address incentive-based compensation arrangements that could lead to 
material financial loss to a covered institution, commenters are asked 
to provide comments on the proposed method of determining asset size 
for investment advisers. Are there instances where it may be 
appropriate to determine asset size differently, by for example, 
including client assets under management for investment advisers? In 
what situations would that be appropriate and why?
    2.11. Should the determination of average total consolidated assets 
for investment advisers exclude non-proprietary assets that are 
included on a balance sheet under accounting rules, such as certain 
types of client assets under management required to be included on an 
investment adviser's balance sheet? Why or why not?
    2.12. Should the determination of average total consolidated assets 
be further tailored for certain types of investment advisers, such as 
charitable advisers, non-U.S.-domiciled advisers, or insurance 
companies and, if so, why and in what manner?
    2.13. The Agencies invite comment on the methods for determining 
whether foreign banking organizations and Federal branches and agencies 
are Level 1, Level 2, or Level 3 covered institutions. Should the same 
method be used for both foreign banking organizations and Federal 
branches and agencies? Why or why not?
Definitions Pertaining to Covered Persons
    Covered person. The proposed rule defines ``covered person'' as any 
executive officer, employee, director, or principal shareholder who 
receives incentive-based compensation at a covered institution.\75\ The 
term ``executive officer'' would include individuals who are senior 
executive officers, as defined in the proposed rule, as well as other 
individuals designated as executive officers by the covered 
institution. As described further below, section __.4 of the proposed 
rule would apply requirements and prohibitions on all incentive-based 
compensation arrangements for covered persons at covered institutions.
---------------------------------------------------------------------------

    \75\ Section 956 requires the Agencies to jointly prescribe 
regulations or guidelines that prohibit certain incentive-based 
compensation arrangements or features of such arrangements that 
encourage inappropriate risk by providing an executive officer, 
employee, director, or principal shareholder with excessive 
compensation, fees, or benefits or that could lead to material 
financial loss to the covered financial institution.
---------------------------------------------------------------------------

    Included in the class of covered persons are senior executive 
officers and significant risk-takers, discussed further below. Senior 
executive officers and significant risk-takers are covered persons that 
may have the ability to expose a covered institution to significant 
risk through their positions or actions. Accordingly, the proposed rule 
would prohibit the incentive-based

[[Page 37691]]

compensation arrangements for senior executive officers and significant 
risk-takers from including certain features that encourage 
inappropriate risk, consistent with the approach under sections __.5, 
__.9, __.10, and __.11 of the proposed rule of requiring risk-
mitigating features for the incentive-based compensation programs at 
larger and more complex covered institutions.
    For Federal credit unions, only one director, if any, would be 
considered a covered person because, under section 112 of the Federal 
Credit Union Act \76\ and NCUA's regulations at 12 CFR 701.33, only one 
director may be compensated as an officer of the board of directors. 
The insurance and indemnification benefits that are excluded from the 
definition of ``compensation'' for purposes of 12 CFR 701.33 would not 
cause a non-compensated director of a credit union to be included under 
the definition of ``covered person'' because these benefits would not 
be ``incentive-based compensation'' under the proposed rule.
---------------------------------------------------------------------------

    \76\ 12 U.S.C. 1761a.
---------------------------------------------------------------------------

    Director. The proposed rule defines ``director'' as a member of the 
board of directors of a covered institution. Any member of a covered 
institution's governing body would be included within this definition.
    Principal shareholder. Section 956 applies to principal 
shareholders as well as executive officers, employees, and directors. 
The proposed rule defines ``principal shareholder'' as a natural person 
who, directly or indirectly, or acting through or in concert with one 
or more persons, owns, controls, or has the power to vote 10 percent or 
more of any class of voting securities of a covered institution. The 10 
percent threshold for identifying principal shareholders is used in a 
number of bank regulatory contexts.\77\ The NCUA's proposed rule does 
not include this definition because credit unions are not-for-profit 
financial cooperatives with member owners. The Agencies recognize that 
some other types of covered institutions, for example, mutual savings 
associations, mutual savings banks, and some mutual holding companies, 
do not have principal shareholders.
---------------------------------------------------------------------------

    \77\ See, e.g., 12 CFR 215.2(m), 12 CFR 225.2(n)(2), and 12 CFR 
225.41(c)(2).
---------------------------------------------------------------------------

    2.14. The Agencies invite comment on whether the definition of 
``principal shareholder'' reflects a common understanding of who would 
be a principal shareholder of a covered institution.
    Senior executive officer. The proposed rule defines ``senior 
executive officer'' as a covered person who holds the title or, without 
regard to title, salary, or compensation, performs the function of one 
or more of the following positions at a covered institution for any 
period of time in the relevant performance period: President, chief 
executive officer (CEO), executive chairman, chief operating officer, 
chief financial officer, chief investment officer, chief legal officer, 
chief lending officer, chief risk officer, chief compliance officer, 
chief audit executive, chief credit officer, chief accounting officer, 
or head of a major business line or control function. As described 
below, a Level 1 or Level 2 covered institution would be required to 
defer a portion of the incentive-based compensation of a senior 
executive officer and subject the incentive-based compensation to 
forfeiture, downward adjustment, and clawback. The proposed rule would 
also limit the extent to which options could be used to meet the 
proposed rule's minimum deferral requirements for senior executive 
officers. The proposed rule would require a covered institution's board 
of directors, or a committee thereof, to approve incentive-based 
compensation arrangements for senior executive officers and any 
material exceptions or adjustments to incentive-based compensation 
policies or arrangements for senior executive officers. Additionally, 
Level 1 and Level 2 covered institutions would be required to create 
and maintain records listing senior executive officers and to document 
forfeiture, downward adjustment, and clawback decisions for senior 
executive officers. The proposed rule would limit the extent to which a 
Level 1 or Level 2 covered institution may award incentive-based 
compensation to a senior executive officer in excess of the target 
amount for the incentive-based compensation. Senior executive officers 
also would not be eligible to serve on the compensation committee of a 
Level 1 or Level 2 covered institution under the proposed rule.
    The 2011 Proposed Rule contained a definition of ``executive 
officer'' that included the positions of president, CEO, executive 
chairman, chief operating officer, chief financial officer, chief 
investment officer, chief legal officer, chief lending officer, chief 
risk officer, and head of a major business line. It did not include the 
positions of chief compliance officer, chief audit executive, chief 
credit officer, chief accounting officer, or head of a control 
function. One commenter asserted that the term ``executive officer'' 
should not be defined with reference to specific position, but, rather, 
should be identified by the board of directors of a covered 
institution. Other commenters asked the Agencies for additional 
specificity about the types of executive officers that would be covered 
at large and small covered institutions, particularly with respect to 
the heads of major business lines. Some commenters encouraged the 
Agencies to align the definition of ``executive officer'' with the 
Securities Exchange Act of 1934 by focusing on individuals with 
significant policymaking functions. In the alternative, some of these 
commenters suggested that the definition be revised to conform to the 
2010 Federal Banking Agency Guidance.
    The definition of ``senior executive officer'' in the proposed rule 
retains the list of positions included in the 2011 Proposed Rule and is 
consistent with other rules and agency guidance. The list includes the 
minimum positions that are considered ``senior executives'' under the 
Federal Banking Agency Safety and Soundness Guidelines.\78\ The 
Agencies also took into account the positions that would be considered 
``officers'' under section 16 of the Securities Exchange Act of 
1934.\79\
---------------------------------------------------------------------------

    \78\ These minimum positions include ``executive officers,'' 
within the meaning of Regulation O (12 CFR 215.2(e)(1)) and ``named 
officers'' within the meaning of the SEC's rules on disclosure of 
executive compensation (17 CFR 229.402). In addition to these 
minimum positions, the Federal Banking Agency Safety and Soundness 
Guidelines also apply to individuals ``who are responsible for 
oversight of the organization's firm-wide activities or material 
business lines.'' 75 FR at 36407.
    \79\ See 17 CFR 240.16a-1.
---------------------------------------------------------------------------

    In addition to the positions listed in the 2011 Proposed Rule, the 
proposed definition of ``senior executive officer'' includes the 
positions of chief compliance officer, chief audit executive, chief 
credit officer, chief accounting officer, and other heads of a control 
function. Individuals in these positions do not generally initiate 
activities that generate risk of material financial loss, but they play 
an important role in identifying, addressing, and mitigating that risk. 
Individuals in these positions have the ability to influence the risk 
measures and other information and judgments that a covered institution 
uses for risk management, internal control, or financial purposes.\80\ 
Improperly structured incentive-based compensation arrangements could 
create incentives for individuals in these positions to use their 
authority in ways that increase, rather than mitigate, risk of material 
financial loss. Some larger institutions have designated

[[Page 37692]]

individuals in these positions as ``covered persons'' for purposes of 
the 2010 Federal Banking Agency Guidance.
---------------------------------------------------------------------------

    \80\ See 2010 Federal Banking Agency Guidance, 75 FR at 36411.
---------------------------------------------------------------------------

    The definition of ``senior executive officer'' also includes a 
covered person who performs the function of a senior executive officer 
for a covered institution, even if the covered person's formal title 
does not reflect that role or the covered person is employed by a 
different entity. For example, under the proposed rule, a covered 
person who is an employee of a bank holding company and also performs 
the functions of a chief financial officer for the subsidiary bank 
would, in addition to being a covered person of the bank holding 
company, also be a senior executive officer of the bank holding 
company's subsidiary bank. This approach would address attempts to 
evade being included within the definition of ``senior executive 
officer'' by changing an individual's title but not that individual's 
responsibilities. In some instances, the determination of senior 
executive officers and compliance with relevant requirements of the 
proposed rule may be influenced by the covered institution's 
organizational structure.\81\ If a covered institution does not have 
any covered person who holds the title or performs the function of one 
or more of the positions listed in the definition of ``senior executive 
officer,'' the proposed rule would not require the covered institution 
to designate a covered person to fill such position for purposes of the 
proposed rule. Similarly, if a senior executive officer at one covered 
institution also holds the title or performs the function of one of 
more of the positions listed for a subsidiary that is also a covered 
institution, then that individual would be a senior executive officer 
for both the parent and the subsidiary covered institutions.
---------------------------------------------------------------------------

    \81\ See section __.3(c) of the proposed rule.
---------------------------------------------------------------------------

    The list of positions in the proposed definition sets forth the 
types of positions whose incumbents would be considered senior 
executive officers. The Agencies are proposing this list to aid covered 
institutions in identifying their senior executive officers while 
allowing the covered institutions some degree of flexibility in 
determining which business lines are major business lines.
    2.15. The Agencies invite comment on whether the types of positions 
identified in the proposed definition of senior executive officer are 
appropriate, whether additional positions should be included, whether 
any positions should be removed, and why.
    2.16. The Agencies invite comment on whether the term ``major 
business line'' provides enough information to allow a covered 
institution to identify individuals who are heads of major business 
lines. Should the proposed rule refer instead to a ``core business 
line,'' as defined in FDIC and FRB rules relating to resolution 
planning (12 CFR 381.2(d)), to a ``principal business unit, division or 
function,'' as described in SEC definitions of the term ``executive 
officer'' (17 CFR 240.3b-7), or to business lines that contribute 
greater than a specified amount to the covered institution's total 
annual revenues or profit? Why?
    2.17. Should the Agencies include the chief technology officer 
(``CTO''), chief information security officer, or similar titles as 
positions explicitly listed in the definition of ``senior executive 
officer''? Why or why not? Individuals in these positions play a 
significant role in information technology management.\82\ The CTO is 
generally responsible for the development and implementation of the 
information technology strategy to support the institution's business 
strategy in line with its appetite for risk. In addition, these 
positions are generally responsible for implementing information 
technology architecture, security, and business resilience.
---------------------------------------------------------------------------

    \82\ See generally Federal Financial Institutions Examination 
Council (``FFIEC'') Information Technology Examination Handbook, 
available at http://ithandbook.ffiec.gov/it-booklets.aspx.
---------------------------------------------------------------------------

    Significant risk-taker. The proposed rule's definition of 
``significant risk-taker'' is intended to include individuals who are 
not senior executive officers but are in the position to put a Level 1 
or Level 2 covered institution at risk of material financial loss so 
that the proposed rule's requirements and prohibitions on incentive-
based compensation arrangements apply to such individuals. In order to 
ensure that incentive-based compensation arrangements for significant 
risk-takers appropriately balance risk and reward, most of the proposed 
rule's requirements for Level 1 and Level 2 covered institutions 
relating to senior executive officers would also apply to significant 
risk-takers to some degree. These requirements include the disclosure 
and recordkeeping requirements of section __.5; the deferral, 
forfeiture, downward adjustment, and clawback requirements of section 
__.7 (including the related limitation on options); and the maximum 
incentive-based compensation opportunity limit of section __.8.
    The proposed definition of ``significant risk-taker'' incorporates 
two tests for determining whether a covered person is a significant 
risk-taker. A covered person would be a significant risk-taker if 
either test was met. The first test is based on the amounts of annual 
base salary and incentive-based compensation of a covered person 
relative to other covered persons working for the covered institution 
and its affiliate covered institutions (the ``relative compensation 
test''). This test is intended to determine whether the individual is 
among the top 5 percent (for Level 1 covered institutions) or top 2 
percent (for Level 2 covered institutions) of highest compensated 
covered persons in the entire consolidated organization, including 
affiliated covered institutions. The second test is based on whether 
the covered person has authority to commit or expose 0.5 percent or 
more of the capital of the covered institution or an affiliate that is 
itself a covered institution (the ``exposure test'').\83\
---------------------------------------------------------------------------

    \83\ In the proposed rule, the Agencies have tailored the 
measure of capital to the type of covered institution. For most 
covered institutions, the exposure test would be based on common 
equity tier 1 capital. For depository institution holding companies, 
foreign banking organizations, and affiliates of those institutions 
that do not report common equity tier 1 capital, the Board would 
work with covered institutions to determine the appropriate measure 
of capital. For registered securities brokers or dealers, the 
exposure test would be based on tentative net capital. See 17 CFR 
240.15c3-1(c)(15). For Federal Home Loan Banks, the exposure test 
would be based on regulatory capital. For the Enterprises, the 
exposure test would be based on minimum capital. For credit unions, 
the exposure test would be based on net worth or total capital. For 
simplicity in describing the exposure test in this Supplementary 
Information section, common equity tier 1 capital, tentative net 
capital, regulatory capital, minimum capital, net worth, and total 
capital are referred to generally as ``capital.'' The Agencies 
expect that a covered institution that is an investment adviser will 
use common equity tier 1 capital or tentative net capital to the 
extent it would be a covered institution in another capacity (e.g., 
if the investment adviser also is a depository institution holding 
company, a bank, a broker-dealer, or a subsidiary of a depository 
institution holding company). For an investment adviser that would 
not be a covered institution in any other capacity, the proposed 
rule's exposure test would not be measured against the investment 
adviser's capital. For a covered person of such an investment 
adviser that can commit or expose capital of an affiliated covered 
institution, the exposure test would be based on common equity tier 
1 capital or tentative net capital of that affiliated covered 
institution. For other covered persons of any investment adviser 
that would not be a covered institution in any other capacity, no 
exposure test is proposed to apply. Comment is requested below 
regarding what measure would be appropriate for an exposure test.
---------------------------------------------------------------------------

    The definition of significant risk-taker applies to only Level 1 
and Level 2 covered institutions. The definition of significant risk-
taker does not apply to senior executive officers. Senior

[[Page 37693]]

executive officers of Level 1 and Level 2 covered institutions would be 
separately subject to the proposed rule, as discussed earlier in this 
Supplemental Information section.
    The significant risk-taker definition under either test would be 
applicable only to covered persons who received annual base salary and 
incentive-based compensation of which at least one-third is incentive-
based compensation (one-third threshold), based on the covered person's 
annual base salary paid and incentive-based compensation awarded during 
the last calendar year that ended at least 180 days before the 
beginning of the performance period for which significant risk-takers 
are being identified.\84\ For example, an individual who received 
$180,000 in annual base salary during calendar year 2019 and was 
awarded incentive-based compensation of $120,000 for performance 
periods that ended during calendar year 2019 could be a significant 
risk-taker because one-third of the individual's compensation was 
incentive-based. Specifically, the individual would be a significant 
risk-taker for a performance period beginning on or after June 28, 2020 
if the individual also met the relative compensation test or the 
exposure test.\85\
---------------------------------------------------------------------------

    \84\ Incentive-based compensation awarded in a particular 
calendar year would include any incentive-based compensation awarded 
with respect to a performance period that ended during that calendar 
year.
    \85\ In this example, incentive-based compensation awarded 
($120,000) would be 40 percent of the total $300,000 received in 
annual base salary ($180,000) and incentive-based compensation 
awarded ($120,000).
---------------------------------------------------------------------------

    Under the proposed rule, in order for covered persons to be 
designated as significant risk-takers, the covered persons would have 
to be awarded a level of incentive-based compensation that would be 
sufficient to influence their risk-taking behavior. In order to ensure 
that significant risk-takers are only those covered persons who have 
incentive-based compensation arrangements that could provide incentives 
to engage in inappropriate risk-taking, only covered persons who meet 
the one-third threshold could be significant risk-takers.
    The proposed one-third threshold is consistent with the more 
conservative end of the range identified in industry practice. 
Institutions in the Board's 2012 LBO Review that would be Level 2 
covered institutions under the proposed rule reported that they 
generally rewarded their self-identified individual risk-takers with 
incentive-based compensation in the range of 8 percent to 90 percent of 
total compensation, with an average range of 32 percent to 71 percent. 
The proposed threshold of one-third or more falls within the lower end 
of that average range.
    The one-third threshold would also be consistent with other 
standards regarding compensation. Under the Emergency Economic 
Stabilization Act of 2008 (as amended by section 7001 of the American 
Recovery and Reinvestment Act of 2009), recipients of financial 
assistance under Treasury's Troubled Asset Relief Program (``TARP'') 
were prohibited from paying or accruing any bonus, retention award, or 
incentive compensation except for the payment of long-term restricted 
stock if that stock had a value that was not greater than one third of 
the total amount of annual compensation of the employee receiving the 
stock.\86\ In addition, some international regulators also use a 
threshold of one-third incentive-based compensation for determining the 
scope of application for certain compensation standards.\87\
---------------------------------------------------------------------------

    \86\ 12 U.S.C. 5221(b)(3)(D).
    \87\ PRA, ``Supervisory Statement LSS8/13, Remuneration 
Standards: The Application of Proportionality'' (April 2013), at 11, 
available at http://www.bankofengland.co.uk/publications/Documents/other/pra/policy/2013/remunerationstandardslss8-13.pdf.
---------------------------------------------------------------------------

    The Agencies included the 180-day period in the one-third threshold 
of annual base salary and incentive-based compensation because, based 
upon the supervisory experience of the Federal Banking Agencies and 
FHFA, this period would allow covered institutions an adequate period 
of time to calculate the total compensation of their covered persons 
and, for purposes of the relative compensation test, the individuals 
receiving incentive-based compensation from their affiliate covered 
institutions over a full calendar year. The Agencies expect, based on 
the experience of exceptional assistance recipients under TARP,\88\ 
that 180 days would be a reasonable period of time for Level 1 and 
Level 2 covered institutions to finalize compensation paid to and 
awarded to covered persons and to perform the necessary calculations to 
determine which covered persons are significant risk-takers. This time 
period would allow covered institutions to make awards following the 
end of the performance period, calculate the annual base salary and 
incentive-based compensation for all employees in the consolidated 
organization, including affiliated covered institutions, and then 
implement new compensation arrangements for the significant risk-takers 
identified, if necessary.
---------------------------------------------------------------------------

    \88\ The institutions that accepted ``exceptional assistance'' 
under TARP were required to submit to the Office of the Special 
Master for approval the compensation levels and structures for the 
five named executive officers and the next 20 most highly 
compensated executive officers (``Top 25'') and the compensation 
structures for the next 75 most highly compensated employees. The 
requirement for submission of the Top 25 necessitated the collection 
of the compensation data for executives worldwide and took 
considerable time and effort on the part of the institutions.
---------------------------------------------------------------------------

    The Agencies recognize that the relative compensation test and the 
exposure test, combined with the one-third threshold, may not identify 
all covered persons at Level 1 and Level 2 covered institutions who 
have the ability to expose a covered institution or its affiliated 
covered institutions to material financial loss. Accordingly, paragraph 
(2) of the proposed rule's definition of significant risk-taker would 
allow covered institutions or the Agencies the flexibility to designate 
additional persons as significant risk-takers. An Agency would be able 
to designate a covered person as a significant risk-taker if the 
covered person has the ability to expose the covered institution to 
risks that could lead to material financial loss in relation to the 
covered institution's size, capital, or overall risk tolerance. Each 
Agency would use its own procedures for making such a designation. Such 
procedures generally would include reasonable advance written notice of 
the proposed action, including a description of the basis for the 
proposed action, and opportunity for the covered person and covered 
institution to respond.
Relative Compensation Test
    The relative compensation test in paragraphs (1)(i) and (ii) of the 
proposed definition of ``significant risk-taker'' would require a 
covered institution to determine which covered persons received the 
most annual base salary and incentive-based compensation among all 
individuals receiving incentive-based compensation from the covered 
institution and any affiliates of the covered institution that are also 
subject to the proposed rule.\89\ The

[[Page 37694]]

definition contains two percentage thresholds for measuring whether an 
individual is a significant risk-taker. For a Level 1 covered 
institution, a covered person would be a significant risk-taker if the 
person receives annual base salary and incentive-based compensation for 
the last calendar year that ended at least 180 days before the 
performance period that places the person among the highest 5 percent 
of all covered persons in salary and incentive-based compensation 
(excluding senior executive officers) of the Level 1 covered 
institution and, in the cases of the OCC, the Board, the FDIC, and the 
SEC, any section 956 affiliates of the Level 1 covered institution. For 
Level 2 covered institutions, the threshold would be 2 percent rather 
than 5 percent.
---------------------------------------------------------------------------

    \89\ The OCC, Board, FDIC, and SEC's proposed rules include a 
defined term, ``section 956 affiliate,'' that is intended to 
function as shorthand for the types of entities that are considered 
``covered institutions'' under the six Agencies' proposed rules. The 
term ``section 956 affiliate'' is used only in the definition of 
``significant risk-taker,'' and it is not intended to affect the 
scope of any Agency's rule or the entities considered ``covered 
institutions'' under any Agency's rule. Given the proposed location 
of each Agency's proposed rule in the Code of Federal Regulations, 
the cross-references used in each of the OCC, Board, FDIC, and SEC's 
proposed rule differ slightly. NCUA's proposed rule does not include 
a definition of ``section 956 affiliate,'' because credit unions are 
not affiliated with the entities that are considered ``covered 
institutions'' under the other Agencies' rules. Similarly, FHFA's 
proposed rule does not include a definition of ``section 956 
affiliate'' because its regulated institutions are not affiliated 
with other Agencies' covered institutions.
---------------------------------------------------------------------------

    For example, if a hypothetical bank holding company were a Level 1 
covered institution and had $255 billion in average total consolidated 
assets might have a subsidiary national bank with $253 billion in 
average total consolidated assets, a mortgage subsidiary with $1.9 
billion in average total consolidated assets, and a wealth management 
subsidiary with $100 million in average total consolidated assets.\90\ 
The relative compensation test would analyze the annual base salary and 
incentive-based compensation of all covered persons (other than senior 
executive officers) who receive incentive-based compensation at the 
bank holding company, the subsidiary national bank, and the mortgage 
subsidiary, which are all covered institutions with assets greater than 
or equal to $1 billion. Individuals at the wealth management subsidiary 
would not be included because that subsidiary has less than $1 billion 
in average total consolidated assets. Thus, if the bank holding 
company, state member bank, and mortgage subsidiary collectively had 
150,000 covered persons (excluding senior executive officers), then the 
covered institution should identify the 7,500 or 5 percent of covered 
persons (other than senior executive officers) who receive the most 
annual base salary and incentive-based compensation out of those 
150,000 covered persons, and identify as significant risk-takers any of 
those 7,500 persons who received annual base salary and incentive-based 
compensation for the last calendar year that ended at least 180 days 
before the beginning of the performance period of which at least one-
third is incentive-based compensation.\91\ Some of those 7,500 covered 
persons might receive incentive-based compensation from the bank 
holding company; others might receive incentive-based compensation from 
the national bank or the mortgage subsidiary. Each covered person that 
satisfies all requirements would be considered a significant risk-taker 
of the covered institution from which they receive incentive-based 
compensation. This example is provided solely for the purpose of 
illustrating the calculation of the number of significant risk-takers 
under the relative compensation test as proposed. It does not reflect 
any specific institution, nor does it reflect the experience or 
judgment of the Agencies of the number of covered persons or 
significant risk-takers at any institution that would be a Level 1 
covered institution under the proposed rule.
---------------------------------------------------------------------------

    \90\ Under the proposed rule, all of these subsidiaries in this 
example other than the wealth management subsidiary would be subject 
to the same requirements as the bank holding company, including the 
specific requirements applying to identification of significant 
risk-takers. The wealth management subsidiary would not be subject 
to the requirements of the proposed rule because it has less than $1 
billion in average total consolidated assets.
    \91\ The Agencies anticipate that covered institutions that are 
within a depository institution holding company structure would work 
together to ensure that significant risk-takers are correctly 
identified under the relative compensation test.
---------------------------------------------------------------------------

    Annual base salary and incentive-based compensation would be 
measured based on the last calendar year that ended at least 180 days 
before the beginning of the performance period for the reasons 
discussed above.
    The Agencies propose that Level 1 and Level 2 covered institutions 
generally should consider a covered person's annual base salary 
actually paid during the calendar year. If, for example, a covered 
person was a manager during the first half of the year, with an annual 
salary of $100,000, and was then promoted to a senior manager with an 
annual salary of $150,000 on July 1 of that year, the annual base 
salary would be the $50,000 that person received as manager for the 
first half of the year plus the $75,000 received as a senior manager 
for the second half of the year, for a total of $125,000.
    For the purposes of determining significant risk-takers, covered 
institutions should consider the incentive-based compensation that was 
awarded for any performance period that ended during a particular 
calendar year, regardless of when the performance period began. For 
example, if a covered person is awarded incentive-based compensation 
relating to (i) a plan with a three-year performance period that began 
on January 1, 2017, (ii) a plan with a two-year performance period that 
began on January 1, 2018, and (iii) a plan with a one-year performance 
period that began on January 1, 2019, then all three of these awards 
would be included in the calculation of incentive-based compensation 
for calendar year 2019 because all three performance periods would end 
on December 31, 2019. The amount of previously deferred incentive-based 
compensation that vests in a particular year would not affect the 
measure of a covered person's incentive-based compensation for purposes 
of the relative compensation test.\92\
---------------------------------------------------------------------------

    \92\ Level 1 and Level 2 covered institutions would also use 
this method of calculating a covered person's incentive-based 
compensation for a particular calendar year for purposes of 
determining (1) whether such person received annual base salary and 
incentive-based compensation of which at least one third was 
incentive-based compensation and (2) the amount of a covered 
person's annual base salary and incentive-based compensation under 
the dollar threshold test.
---------------------------------------------------------------------------

    To reduce the administrative burden of calculating annual base 
salary and incentive-based compensation, the calculation would not 
include fringe benefits such as the value of medical insurance or the 
use of a company car. For purposes of such calculation, any non-cash 
compensation, such as stock or options, should be valued as of the date 
of the award.
    In the Agencies' supervisory experience, the amount of a covered 
person's annual base salary and incentive-based compensation can 
reasonably be expected to relate to the amount of responsibility that 
the covered person has within an organization, and covered persons with 
a higher level of responsibility generally either (1) have a greater 
ability to expose a covered institution to financial loss or (2) 
supervise covered persons who have a greater ability to expose a 
covered institution to financial loss. For this reason, the Agencies 
are proposing to use the relative compensation test as one basis for 
identifying significant risk-takers.
    Although a large number of covered persons may be able to expose a 
covered institution to a financial loss, the Agencies have limited the 
relative compensation test to the most highly compensated individuals 
in order to focus on those covered persons whose behavior can directly 
or indirectly expose a Level 1 or Level 2 covered institution to a 
financial loss that is material. Based on an analysis of public 
disclosures of large, international banking organizations \93\ and on 
the

[[Page 37695]]

Agencies' own supervision of incentive-based compensation, the top 5 
percent most highly compensated covered persons among the covered 
institutions in the consolidated structure of Level 1 covered 
institutions are the most likely to have the potential to encourage 
inappropriate risk-taking by the covered institution because their 
compensation is excessive (the first test in section 956) or be the 
personnel who are able to expose the organization to risk of material 
financial loss (the second test in section 956).
---------------------------------------------------------------------------

    \93\ Agencies examined information available through various 
public reports, including the FSB's annual Compensation Progress 
Report. For instance, many international jurisdictions require firms 
to identify a population of employees who can expose a firm to 
material amounts of risk (sometimes called material risk takers or 
key risk takers), who are subject to specific requirements including 
deferral. In 2014 the FSB published information indicating that the 
average percentage of total global employees identified as risk-
takers under these various jurisdictions' requirements at a sample 
of large firms ranged from 0.01 percent of employees of the global 
consolidated organization to more than 5 percent. The number varied 
between, but also within, individual jurisdictions and institutions 
as a result of factors such as specific institutions surveyed, the 
size of institution, and the nature of business conducted. See FSB, 
Implementing the FSB Principles for Sound Compensation Practices and 
their Implementation Standards Third Progress Report (November 
2014), at 19, available at http://www.fsb.org/2014/11/fsb-publishes-third-progress-report-on-compensation-practices.
    In addition, the Agencies relied to a certain extent on 
information disclosed on a legal entity basis as a result of Basel 
Pillar 3 remuneration disclosure requirements, for instance those 
required under implementing regulations such as Article 450 of the 
Capital Requirements Regulation (EU No 575/2013) in the European 
Union. See, e.g., Morgan Stanley, Article 450 of CRR Disclosure: 
Remuneration Policy (December 31, 2014), available at http://www.morganstanley.com/about-us-ir/pillar3/2014_CRR_450_Disclosure.pdf. Remuneration disclosure requirements 
apply to ``significant'' firms. CRD IV defines institutions that are 
significant ``in terms of size, internal organisation and nature, 
scope and complexity of their activities.'' Under the EBA Guidance 
on Sound Remuneration Policies, significant institutions means 
institutions referred to in Article 131 of Directive 2013/36/EU 
(global systemically important institutions or `G-SIIs,' and other 
systemically important institutions or `O-SIIs'), and, as 
appropriate, other institutions determined by the competent 
authority or national law, based on an assessment of the 
institutions' size, internal organization and the nature, the scope 
and the complexity of their activities. Some, but not all, national 
regulators have provided further guidance on interpretation of that 
term, including the United Kingdom's FCA which provides a form of 
methodology to determine if a firm is ``significant''--based on 
quantitative tests of balance sheet assets, liabilities, annual fee 
commission income, client money and client assets.
---------------------------------------------------------------------------

    The Board and the OCC, as a part of their supervisory efforts, 
reviewed a limited sample of banking organizations with total 
consolidated assets of $50 billion or more to better understand what 
types of positions within these organizations would be captured by 
various thresholds for highly compensated employees. In the review, the 
Board and the OCC also considered how far below the CEO within the 
organizational hierarchy the selected thresholds would reach. 
Generally, at banking organizations that would be Level 1 covered 
institutions under the proposed rule, a 5 percent threshold would 
include positions such as managing directors, directors, senior vice 
presidents, relationship and sales managers, mortgage brokers, 
financial advisors, and product managers. Such positions generally have 
the ability to expose the organization to the risk of material 
financial loss. Based on this review, the Agencies believe it is 
reasonable to propose a 5 percent threshold under the relative 
compensation test for Level 1 covered institutions.
    At banking organizations that would be Level 2 covered institutions 
under the proposed rule, a 5 percent threshold yielded results that 
went much deeper into the organization and identified roles with 
individuals who might not individually take significant risks for the 
organization. Additional review of a limited sample of these banking 
organizations that would be Level 2 covered institutions under the 
proposed rule showed that, on average, the institutions in the limited 
sample identified approximately 2 percent of their total global 
employees as individual employees whose activities may expose the 
organization to material amounts of risk, as consistent with the 2010 
Federal Banking Agency Guidance. A lower percentage threshold for Level 
2 covered institutions relative to Level 1 covered institutions also is 
consistent with the observation that larger covered institutions 
generally have more complex structures and use incentive-based 
compensation more significantly than relatively smaller covered 
institutions. Based on this analysis, the Agencies chose to propose a 2 
percent threshold for Level 2 covered institutions. A lower percentage 
threshold for Level 2 covered institutions relative to Level 1 covered 
institutions would reduce the burden on relatively smaller covered 
institutions.
    Under the proposed rule, if an Agency determines, in accordance 
with procedures established by the Agency, that a Level 1 covered 
institution's activities, complexity of operations, risk profile, and 
compensation practices are similar to those of a Level 2 covered 
institution, then the Agency may apply a 2 percent threshold under the 
relative compensation test rather than the 5 percent threshold that 
would otherwise apply. This provision is intended to allow an Agency 
the flexibility to adjust the number of covered persons who are 
significant risk-takers with respect to a Level 1 covered institution 
if the Agency determines that, notwithstanding the Level 1 covered 
institution's average total consolidated assets, its actual activities 
and risks are similar to those of a Level 2 covered institution, and 
therefore it would be appropriate for the Level 1 covered institution 
to have fewer significant risk-takers.
Exposure Test
    Under the exposure test, a covered person would be a significant 
risk-taker with regard to a Level 1 or Level 2 covered institution if 
the individual may commit or expose \94\ 0.5 percent or more of capital 
of the covered institution or, and, in the cases of the OCC, the Board, 
the FDIC, and the SEC, any section 956 affiliates of the covered 
institution, whether or not the individual is employed by that specific 
legal entity.
---------------------------------------------------------------------------

    \94\ An individual may commit or expose capital of a covered 
institution or affiliate if the individual has the ability to put 
the capital at risk of loss due to market risk or credit risk.
---------------------------------------------------------------------------

    The exposure test relates to a covered person's authority to commit 
or expose significant amounts of an institution's capital, regardless 
of whether or not such exposures or commitments are realized. The 
exposure test would relate to a covered person's authority to cause the 
covered institution to be subject to credit risk or market risk. The 
exposure test would not relate to the ability of a covered person to 
expose a covered institution to other types of risk that may be more 
difficult to measure or quantify, such as compliance risk.
    The measure of capital would relate to a covered person's authority 
over the course of the most recent calendar year, in the aggregate, and 
would be based on the maximum amount that the person has authority to 
commit or expose during the year. For example, a Level 1 or Level 2 
covered institution might allocate $10 million to a particular covered 
person as an authorized level of lending for a calendar year. For 
purposes of the exposure test in the proposed rule, the covered 
person's authority to commit or expose would be $10 million. This would 
be true even if the individual only made $8 million in loans during the 
year or if the covered institution reduced the authorized amount to 
$7.5 million at some point during the year. It would also be true even 
if the covered person did not have the authority through any single 
transaction to lend $10 million, so long as over the course of the year 
the covered person could lend up to $10 million in the aggregate. If, 
however, in

[[Page 37696]]

the course of the year the covered person received authorization for an 
additional $5 million in lending, $15 million would become the 
authorization amount for purposes of the exposure test. If a covered 
person had no specific maximum amount of lending for the year, but 
instead his or her lending was subject to approval on a rolling basis, 
then the covered person would be assumed to have an authorized annual 
lending amount in excess of the 0.5 percent threshold.
    As an additional example, a Level 1 or Level 2 covered institution 
could authorize a particular covered person to trade up to $5 million 
per day in a calendar year. For purposes of the exposure test, the 
covered person's authorized annual lending amount would be $5 million 
times the number of trading days in the year (for example, $5 million 
times 260 days or $1.3 billion). This would be true even if the covered 
person only traded $1 million per day during the year or if the covered 
institution reduced the authorized trading amount to $2.5 million per 
day at some point during the year. If, however, in the course of the 
year the covered person received authorization for an additional $2 
million in trading per day, the covered person's authority to commit or 
expose capital for purposes of the exposure test would be $1.82 billion 
($7 million times 260 days). The Agencies are aware that institutions 
may not calculate their exposures in this manner and are requesting 
comment upon it, as set forth below.
    The exposure test would also include individuals who are voting 
members of a committee that has the decision-making authority to commit 
or expose 0.5 percent or more of the capital of a covered institution 
or of a section 956 affiliate of a covered institution. For example, if 
a committee that is comprised of five covered persons has the authority 
to make investment decisions with respect to 0.5 percent or more of a 
state member bank's capital, then each voting member of such committee 
would have the authority to commit or expose 0.5 percent or more of the 
state member bank's capital for purposes of the exposure test. However, 
individuals who participate in the meetings of such a committee but who 
do not have the authority to exercise voting, veto, or similar rights 
that lead to the committee's decision would not be included.
    The exposure test would also cause a covered person to be 
considered a significant risk-taker if he or she can commit or expose 
0.5 percent or more of the capital of any section 956 affiliate of the 
covered institution by which the covered person is employed. For 
example, if a covered person of a nonbank subsidiary of a bank holding 
company has the authority to commit 0.5 percent or more of the bank 
holding company's capital or the capital of the bank holding company's 
subsidiary national bank (and received annual base salary and 
incentive-based compensation for the last calendar year that ended at 
least 180 days before the beginning of the performance period of which 
at least one-third is incentive-based compensation), then the covered 
person would be considered a significant risk-taker of the bank holding 
company or national bank, whichever is applicable. This would be true 
even if the covered person is not employed by the bank holding company 
or the bank holding company's subsidiary national bank, and even if the 
covered person does not have the authority to commit or expose the 
capital of the nonbank subsidiary that employs the covered person.
    The exposure test would require a Level 1 or Level 2 covered 
institution to consider the authority of an individual to take an 
action that could result in significant credit or market risk exposures 
to the covered institution. The Agencies are proposing the exposure 
test because individuals who have the authority to expose covered 
institutions to significant amounts of risk can cause material 
financial losses to covered institutions. For example, in proposing the 
exposure test, the Agencies were cognizant of the significant losses 
caused by actions of individuals, or a trading group, at some of the 
largest financial institutions during and after the financial crisis 
that began in 2007.\95\
---------------------------------------------------------------------------

    \95\ See supra note 14.
---------------------------------------------------------------------------

    The exposure test would identify significant risk-takers based on 
the extent of an individual's authority to expose an institution to 
market risk or credit risk, measured by reference to 0.5 percent of the 
covered institution's regulatory capital. Measuring this authority by 
reference to an existing capital standard would provide a uniform and 
clearly defined metric to apply among covered persons at Level 1 and 
Level 2 covered institutions. The Agencies have selected credit and 
market risks as the most relevant types of exposures because the 
majority of assets on a covered institution's balance sheet generally 
give rise to market or credit risk exposure.
    In proposing a threshold of 0.5 percent of relevant capital, the 
Agencies considered both the absolute and relative amount of losses 
that the threshold would represent for covered institutions, and the 
fact that incentive-based compensation programs generally apply to 
numerous employees at a covered institution. In the Agencies' view, the 
proposed threshold represents a material financial loss within the 
meaning of section 956 for any institution and multiple losses at the 
same firm incentivized by a single incentive-based compensation program 
could impair the firm.
    The Agencies considered the cumulative effect of incentive-based 
compensation arrangements across a covered institution. The Agencies 
recognize that many covered persons who have the authority to expose a 
covered institution to risk are subject to similar incentive-based 
compensation arrangements. The effect of an incentive-based 
compensation arrangement on a covered institution would be the 
cumulative effect of the behavior of all covered persons subject to the 
incentive-based compensation arrangement. If multiple covered persons 
are incented to take inappropriate risks, their combined risk-taking 
behavior could lead to a financial loss at the covered institution that 
is significantly greater than the financial loss that could be caused 
by any one individual.\96\ Although many institutions already have 
governance and risk management systems to help ensure the commitment of 
significant amounts of capital is subject to appropriate controls, as 
noted above, incentive-based compensation arrangements that provide 
inappropriate risk-taking incentives can weaken those governance and 
risk management systems. These considerations about the cumulative 
effect of incentive-based compensation arrangements weigh in favor of a 
conservative threshold under the exposure test so that large groups of 
covered persons with the authority to commit a covered institution's 
capital are not subject to flawed incentive-based compensation 
arrangements which would incentivize them to subject the covered 
institution to inappropriate risks.
---------------------------------------------------------------------------

    \96\ See, e.g., the Subcommittee Report.
---------------------------------------------------------------------------

    The Agencies also considered that in another regulatory context, a 
relatively small decrease in a large institution's capital requires 
additional safeguards for safety and soundness. Under the capital plan 
rule in the Board's Regulation Y, well-capitalized bank holding 
companies with average total consolidated assets of $50 billion or more 
are subject to prior approval requirements on incremental capital

[[Page 37697]]

distributions if those distributions, as measured over a one-year 
period, would exceed pre-approved amounts by more than 1 percent of the 
bank holding company's tier 1 capital.\97\ Relative to the capital plan 
rule, a lower threshold of capital is appropriate in the context of 
incentive-based compensation in light of the potential cumulative 
effect of multiple covered persons with incentives to take 
inappropriate risks and the possibility that correlated inappropriate 
risk-taking incentives could, in the aggregate, significantly erode 
capital buffers at Level 1 and Level 2 covered institutions.
---------------------------------------------------------------------------

    \97\ See 12 CFR 225.8(g). Bank holding companies that are well-
capitalized and that meet other requirements under the rule must 
provide the Board with prior notice for incremental capital 
distributions, as measured over a one-year period, that represent 
more than 1 percent of their tier 1 capital. Id.
---------------------------------------------------------------------------

    Taking into consideration the cumulative impact of incentive-based 
compensation arrangements described above, the Agencies have proposed a 
threshold level for the exposure test of 0.5 percent of capital. The 
exposure test would be measured on an annual basis to align with the 
common practice at many institutions of awarding incentive-based 
compensation on an annual basis, taking into account a covered person's 
performance and risk-taking over 12 months.
    The Agencies also considered international compensation regulations 
that also use a 0.5 percent threshold, but on a per transaction 
basis.\98\ The Agencies are proposing to apply the threshold on an 
aggregate annual basis because a per transaction basis could permit an 
individual to evade designation as a significant risk-taker and the 
related incentive-based compensation restrictions by keeping his or her 
individual transactions below the threshold, but completing multiple 
transactions during the course of the year that, in the aggregate, far 
exceed the threshold.
---------------------------------------------------------------------------

    \98\ See, e.g., EBA, ``Regulatory Technical Standards on 
Criteria to Identify Categories of Staff Whose Professional 
Activities Have a Material Impact on an Institution's Risk Profile 
under Article 94(2) of Directive 2013/36/EU'' (December 16, 2013), 
available athttps://www.eba.europa.eu/documents/10180/526386/EBA-RTS-2013-11+%28On+identified+staff%29.pdf/c313a671-269b-45be-a748-29e1c772ee0e.
---------------------------------------------------------------------------

Exposure Test at Certain Affiliates
    Paragraph (3) of the definition of significant risk-taker is 
intended to address potential evasion of the exposure test by a Level 1 
or Level 2 covered institution that authorizes an employee of one of 
its affiliates that is not a covered institution because it has less 
than $1 billion in average total consolidated assets or is not 
considered a covered institution under one of the six Agencies' 
proposed rules, to commit or expose 0.5 percent or more of capital of 
the Level 1 or Level 2 covered institution. The Agencies are concerned 
that in such a situation, the employee would be functioning as a 
significant risk-taker at the affiliated Level 1 or Level 2 covered 
institution but would not be subject to the requirements of the 
proposed rule that would be applicable to a significant risk-taker at 
the affiliated Level 1 or Level 2 covered institution. To address this 
circumstance, the proposed rule would treat such employee as a 
significant risk-taker with respect to the affiliated Level 1 or Level 
2 covered institution for which the employee may commit or expose 
capital. That Level 1 or Level 2 covered institution would be required 
to ensure that the employee's incentive-based compensation arrangement 
complies with the proposed rule.
Dollar Threshold Test
    As an alternative to the relative compensation test, the Agencies 
also considered using a specific absolute compensation threshold, 
measured in dollars, to determine whether an individual is a 
significant risk-taker. Under this test, a covered person who receives 
annual base salary and incentive-based compensation \99\ in excess of a 
specific dollar threshold would be a significant risk-taker, regardless 
of how that covered person's annual base salary and incentive-based 
compensation compared to others in the consolidated organization (the 
``dollar threshold test''). A dollar threshold test would include 
adjustments such as for inflation. If the dollar threshold test 
replaced the relative compensation test, the definition of 
``significant risk-taker'' would still include only covered persons who 
received annual base salary and incentive-based compensation of which 
at least one-third was incentive-based compensation, based on the 
covered person's annual base salary paid and incentive-based 
compensation awarded during the last calendar year that ended at least 
180 days before the beginning of the performance period.
---------------------------------------------------------------------------

    \99\ For purposes of the dollar threshold test, the measure of 
annual base salary and incentive-based compensation would be 
calculated in the same way as the measure for the one-third 
threshold discussed above.
---------------------------------------------------------------------------

    One advantage of a dollar threshold test compared to the relative 
compensation test is that it could be less burdensome to implement and 
monitor. With a dollar threshold test covered institutions can 
determine whether an individual covered person meets the dollar 
threshold test of the significant risk-taker definition by reviewing 
the compensation of only that single individual. The dollar threshold 
test would also allow an institution to implement incentive-based 
compensation structures, policies, and procedures with some 
foreknowledge of which employees would be covered by them. However, 
even with adjustment for inflation, a dollar threshold put in place by 
regulation would assume that a certain dollar threshold is an 
appropriate level for all Level 1 and Level 2 covered institutions and 
covered persons. On the other hand, a dollar threshold could set 
expectations so that individual employees would know based on their own 
compensation if they are significant risk-takers.
    Based on FHFA's supervisory experience analyzing compensation both 
at FHFA's regulated entities and at other financial institutions, a 
dollar threshold would be an appropriate approach to identify 
individuals with the ability to put the covered institution at risk of 
material loss. FHFA must prohibit its regulated entities from providing 
compensation to any executive officer of the regulated entity that is 
not reasonable and comparable with compensation for employment in other 
similar businesses (including publicly held financial institutions or 
major financial services companies) involving similar duties and 
responsibilities.\100\ In order to meet this statutory mandate, FHFA 
analyzes, assesses, and compares the compensation paid to employees of 
its regulated entities and compensation paid to employees of other 
financial institutions of various asset sizes. In performing this 
analysis, FHFA has observed that the amount of a covered person's 
annual base salary and incentive-based compensation reasonably relates 
to the level of responsibility that the covered person has within an 
organization. A dollar threshold test, if set at the appropriate level, 
would identify covered persons who either (1) have a greater ability to 
expose a covered institution to financial loss or (2) supervise covered 
persons who have a greater ability to expose a covered institution to 
financial loss.
---------------------------------------------------------------------------

    \100\ 12 U.S.C. 4518(a).
---------------------------------------------------------------------------

    One disadvantage of the dollar threshold test is that it may not 
appropriately capture all individuals who subject the firm to 
significant risks. A dollar threshold put in place by regulation that 
is static across all Level 1 and Level 2 covered institutions also is 
not sensitive to the compensation

[[Page 37698]]

practices of an individual organization. The relative compensation 
test, while not as easy to implement, could be more sensitive to the 
compensation structure of an organization because it is based on the 
relative compensation of individuals that the organization concludes 
should be the mostly highly compensated.
    2.18. For purposes of a designation under paragraph (2) of the 
definition of significant risk-taker, should the Agencies provide a 
specific standard for what would constitute ``material financial loss'' 
and/or ``overall risk tolerance''? If so, how should these terms be 
defined and why?
    2.19. The Agencies specifically invite comment on the one-third 
threshold in the proposed rule. Is one-third of the total of annual 
base salary and incentive-based compensation an appropriate threshold 
level of incentive-based compensation that would be sufficient to 
influence risk-taking behavior? Is using compensation from the last 
calendar year that ended at least 180 days before the beginning of the 
performance period for calculating the one-third threshold appropriate?
    2.20. The Agencies specifically invite comment on the percentages 
of employees proposed to be covered under the relative compensation 
test. Are 5 percent and 2 percent reasonable levels? Why or why not? 
Would 5 percent and 2 percent include all of the significant risk-
takers or include too many covered persons who are not significant 
risk-takers?
    2.21. The Agencies specifically invite comment on the time frame 
needed to identify significant risk-takers under the relative 
compensation test. Is using compensation from the last calendar year 
that ended at least 180 days before the beginning of the performance 
period appropriate? The Agencies invite comment on whether there is 
another measure of total compensation that would be possible to measure 
closer in time to the performance period for which a covered person 
would be identified as a significant risk-taker.
    2.22. The Agencies invite comment on all aspects of the exposure 
test, including potential costs and benefits, the appropriate exposure 
threshold and capital equivalent, efficacy at identifying those non-
senior executive officers who have the authority to place the capital 
of a covered institution at risk, and whether an exposure test is a 
useful complement to the relative compensation test. If so, what 
specific types of activities or transactions, and at what level of 
exposure, should the exposure test cover? The Agencies also invite 
comment on whether the exposure test is workable and why. What, if any, 
additional details would need to be specified in order to make the 
exposure test workable, such as further explanation of the meanings of 
``commit'' or ``expose''? In addition to committees, should the 
exposure test apply to groups of persons, such as traders on a desk? If 
so, how should it be applied?
    2.23. With respect to the exposure test, the Agencies specifically 
invite comment on the proposed capital commitment levels. Is 0.5 
percent of capital of a covered institution a reasonable proxy for 
material financial loss, or are there alternative levels or dollar 
thresholds that would better achieve the statutory objectives? If 
alternative methods would better achieve the statutory objectives, what 
are the advantages and disadvantages of those alternatives compared to 
the proposed level? For depository institution holding company 
organizations with multiple covered institutions, should the capital 
commitment level be consistent across all such institutions or should 
it vary depending on specified factors and why? For example, should the 
levels for covered institutions that are subsidiaries of a parent who 
is also a covered institution vary depending on: (1) The size of those 
subsidiaries relative to the parent; and/or (2) whether the entity 
would be subject to comparable restrictions if it were not affiliated 
with the parent? What are the advantages and disadvantages of any such 
variation, and what would be the appropriate levels? The Agencies 
recognize that certain covered institutions under the Board's, the 
OCC's, the FDIC's, and the SEC's proposed rules, such as Federal and 
state branches and agencies of foreign banks and investment advisers 
that are not also depository institution holding companies, banks, or 
broker-dealers or subsidiaries of those institutions, are not otherwise 
required to calculate common equity tier 1 capital or tentative net 
capital, as applicable. How should the capital commitment level be 
determined under the Board's, the OCC's, the FDIC's, and the SEC's 
proposed rules for those covered institutions? Is there a capital or 
other measure that the Agencies should consider for those covered 
institutions that would achieve similar objectives to common equity 
tier 1 capital or tentative net capital? If so, what are the advantages 
and disadvantages of such a capital or other measure?
    2.24. The Agencies invite comment on whether it is appropriate to 
limit the exposure test to market risk and credit risk and why. What 
other types of risk should be included, if any and how would such 
exposures be measured? Should the Agencies prescribe a method for 
measurement of market risk and credit risk? Should exposures be 
measured as notional amounts or is there a more appropriate measure? If 
so, what would it be? Should the exposure test take into account 
hedging? How should the exposure test be applied to an individual in a 
situation where a firm calculates an exposure limit for a trading desk 
comprised of a group of people? Should a de minimis threshold be 
introduced for any transaction counted toward the 0.5 percent annual 
exposure test?
    2.25. Should the exposure test consider the authority of a covered 
person to initiate or structure proposed product offerings, even if the 
covered person does not have final decision-making authority over such 
product offerings? Why or why not? If so, are there specific types of 
products with respect to which this approach would be appropriate and 
why?
    2.26. Should the exposure test measure a covered person's authority 
to commit or expose (a) through one transaction or (b) as currently 
proposed, through multiple transactions in the aggregate over a period 
of time? What would be the benefits and disadvantages of applying the 
test on a per-transaction versus aggregate basis over a period of time? 
If measured on an aggregate basis, what period of time is appropriate 
and why? For example, should paragraph (1)(iii) of the definition of 
significant risk-taker read: ``A covered person of a covered 
institution who had the authority to commit or expose in any single 
transaction during the previous calendar year 0.5 percent or more of 
the capital \101\ of the covered institution or of any section 956 
affiliate of the covered institution, whether or not the individual is 
a covered person of that specific legal entity''? Why or why not?
---------------------------------------------------------------------------

    \101\ Under this alternative language, each Agency's rule text 
would include the relevant capital metrics for its covered 
institutions.
---------------------------------------------------------------------------

    2.27. If the exposure test were based on a single transaction, 
would 0.5 percent of capital be the appropriate threshold for 
significant risk-taker status? Why or why not? If not, what would be 
the appropriate percentage of capital to include in the exposure test 
and why?
    2.28. Should the Agencies introduce an absolute exposure threshold 
in addition to a percentage of capital test if a per-transaction test 
was introduced instead of the annual exposure test? Why or why not? For 
example, would a threshold formulated as ``the lesser of 0.5 percent of 
capital or $100 million''

[[Page 37699]]

help to level the playing field across Level 1 covered institutions and 
the smallest Level 2 covered institutions and better ensure that the 
right set of activities is being considered by all institutions? The 
Agencies' supervisory experience indicates that many large 
institutions, for example, require additional scrutiny of significant 
transactions, which helps to ensure that the potential risks posed by 
large transactions are adequately considered before such transactions 
are approved. Would $100 million be the appropriate level at which 
additional approval procedures are required before a transaction is 
approved, or would a lower threshold be appropriate if an absolute 
dollar threshold were combined with the capital equivalent threshold?
    2.29. Should the exposure test measure exposures or commitments 
actually made, or should the authority to make an exposure or 
commitment be sufficient to meet the test and why? For example, should 
paragraph (1)(iii) of the definition of significant risk-taker read: 
``A covered person of a covered institution who committed or exposed in 
the aggregate during the previous calendar year 0.5 percent or more of 
the common equity tier 1 capital, or in the case of a registered 
securities broker or dealer, 0.5 percent or more of the tentative net 
capital, of the covered institution or of any section 956 affiliate of 
the covered institution, whether or not the individual is a covered 
person of that specific legal entity''?
    2.30. Would a dollar threshold test, as described above, achieve 
the statutory objectives better than the relative compensation test? 
Why or why not? If using a dollar threshold test, and assuming a 
mechanism for inflation adjustment, would $1 million be the right 
threshold or should it be higher or lower? For example, would a 
threshold of $2 million dollars be more appropriate? Why or why not? 
How should the threshold be adjusted for inflation? Are there other 
adjustments that should be made to ensure the threshold remains 
appropriate? What are the advantages and disadvantages of a dollar 
threshold test compared to the proposed relative compensation test?
    2.31. The Agencies specifically invite comment on replacement of 
the relative compensation test in paragraphs (1)(i) and (ii) of the 
definition of significant risk-taker with a dollar threshold test, as 
follows: ``a covered person of a Level 1 or Level 2 covered institution 
who receives annual base salary and incentive-based compensation of $1 
million or more in the last calendar year that ended at least 180 days 
before the beginning of the performance period.'' Under this 
alternative, the remaining language in the definition of ``significant 
risk-taker'' would be unchanged.
    2.32. The Agencies invite comment on all aspects of a dollar 
threshold test, including potential costs and benefits, the appropriate 
amount, efficacy at identifying those non-senior executive officers who 
have the ability to place the institution at risk, time frame needed to 
identify significant risk-takers, and comparison to a relative 
compensation test such as the one proposed. Is the last calendar year 
that ended at least 180 days before the beginning of the performance 
period an appropriate time frame or for the dollar threshold test or 
would using compensation from the performance period that ended in the 
most recent calendar year be appropriate? The Agencies specifically 
invite comment on whether to use an exposure test if a dollar threshold 
test replaces the relative compensation test and why.
    2.33. The Agencies invite comment on all aspects of the definition 
of ``significant risk-taker.'' The Agencies specifically invite comment 
on whether the definition should rely solely on the relative 
compensation test, solely on the exposure test, or on both tests, as 
proposed. What are the advantages and disadvantages of each of these 
options?
    2.34. In addition to the tests outlined above, are there 
alternative tests of, or proxies for, significant risk-taking that 
would better achieve the statutory objectives? What are the advantages 
and disadvantages of alternative approaches? What are the 
implementation burdens of any of the approaches, and how could they be 
addressed?
    2.35. How many covered persons would likely be identified as 
significant risk-takers under the proposed rule? How many covered 
persons would likely be identified under only the relative compensation 
test with the one-third threshold? How many covered persons would 
likely be identified under only the exposure test as measured on an 
annual basis with the one-third threshold? How many covered persons 
would be identified under only an exposure test formulated on a per 
transaction basis with the one-third threshold? How many covered 
persons would be identified under only the dollar threshold test, 
assuming the dollar threshold is $1 million, with the one-third 
threshold? How many covered persons would be identified under each test 
individually without a one-third threshold?
Other Definitions
    To award. The proposed rule defines ``to award'' as to make a final 
determination, conveyed to a covered person, of the amount of 
incentive-based compensation payable to the covered person for 
performance over a performance period.
    The Agencies acknowledge that some covered institutions use the 
term ``award'' to refer to the decisions that covered institutions make 
about incentive-based compensation structures and performance measure 
targets before or soon after the relevant performance period begins. 
However, in the interest of clarity and consistency, the proposed rule 
uses the phrase ``to award'' only with reference to final 
determinations about incentive-based compensation amounts that an 
institution makes and communicates to the covered person who could 
receive the award under an incentive-based compensation arrangement for 
a given performance period.
    In most cases, incentive-based compensation will be awarded near 
the end of the performance period. Neither the length of the 
performance period nor the decision to defer some or all incentive-
based compensation would affect the determination of when incentive-
based compensation is awarded for purposes of the proposed rule. For 
example, at the beginning of a one-year performance period, a covered 
institution might inform a covered person of the amount of incentive-
based compensation that the covered person could earn at the end of the 
performance period if certain measures and other criteria are met. The 
covered institution might also inform the covered person that a portion 
of the covered person's incentive-based compensation will be deferred 
for a four-year period. The covered person's incentive-based 
compensation for that performance period--including both the portion 
that is deferred and the portion that vests immediately--would be 
``awarded'' when the covered institution determines what amount of 
incentive-based compensation the covered person has earned based on his 
or her performance during the performance period.
    For equity-like instruments, such as stock appreciation rights and 
options, the date when incentive-based compensation is awarded may be 
different than from the date when the instruments vest, are paid out, 
or can be exercised. For example, a covered institution could determine 
at the end of a performance period that a covered person has earned 
options on the basis of performance during that performance

[[Page 37700]]

period, and the covered institution could provide that the covered 
person cannot exercise the options for another five years. The options 
would be considered to have been ``awarded'' at the end of the 
performance period, even if they cannot be exercised for five years.
    Under the proposed rule, covered institutions would have the 
flexibility to decide how the determination of the amount of incentive-
based compensation would be conveyed to a covered person. For example, 
some covered institutions may choose to inform covered persons of their 
award amounts in writing or by electronic message. Others may choose to 
allow managers to orally inform covered persons of their award amounts.
    2.36. The Agencies invite comment on whether the proposed rule's 
definition of ``to award'' should include language on when incentive-
based compensation is awarded for purposes of the proposed rule. 
Specifically, the Agencies invite comment on whether the definition 
should read: ``To award incentive-based compensation means to make a 
final determination, conveyed to a covered person, at the end of the 
performance period, of the amount of incentive-based compensation 
payable to the covered person for performance over that performance 
period.'' Why or why not?
    Board of directors. The proposed rule defines ``board of 
directors'' as the governing body of a covered institution that 
oversees the activities of the covered institution, often referred to 
as the board of directors or board of managers. Under the Board's 
proposed rule, for a foreign banking organization, ``board of 
directors'' would mean the relevant oversight body for the 
institution's state insured or uninsured branch, agency, or operations, 
consistent with the foreign banking organization's overall corporate 
and management structure. Under the FDIC's proposed rule, for a state 
insured branch of a foreign bank, ``board of directors'' would refer to 
the relevant oversight body for the state insured branch consistent 
with the foreign bank's overall corporate and management structure. 
Under the OCC's proposed rule, for a Federal branch or agency of a 
foreign bank, ``board of directors'' would refer to the relevant 
oversight body for the Federal branch or agency, consistent with its 
overall corporate and management structure. The OCC would work closely 
with Federal branches and agencies to determine the appropriate person 
or committee to undertake the responsibilities assigned to the 
oversight body. NCUA's proposed rule defines ``board of directors'' as 
the governing body of a credit union.
    Clawback. The term ``clawback'' under the proposed rule refers 
specifically to a mechanism that allows a covered institution to 
recover from a senior executive officer or significant risk-taker 
incentive-based compensation that has vested if the covered institution 
determines that the senior executive officer or significant risk-taker 
has engaged in fraud or the types of misconduct or intentional 
misrepresentation described in section __.7(c) of the proposed rule. 
Clawback would not apply to incentive-based compensation that has been 
awarded but is not yet vested. As used in the proposed rule, the term 
``clawback'' is distinct from the terms ``forfeiture'' and ``downward 
adjustment,'' in that clawback provisions allow covered institutions to 
recover incentive-based compensation that has already vested. In 
contrast, forfeiture applies only after incentive-based compensation is 
awarded but before it vests. Downward adjustment occurs only before 
incentive-based compensation is awarded.
    Compensation, fees, or benefits. The proposed rule defines 
``compensation, fees, or benefits'' to mean all direct and indirect 
payments, both cash and non-cash, awarded to, granted to, or earned by 
or for the benefit of, any covered person in exchange for services 
rendered to the covered institution. The form of payment would not 
affect whether such payment meets the definition of ``compensation, 
fees, or benefits.'' The term would include, among other things, 
payments or benefits pursuant to an employment contract, compensation, 
pension, or benefit agreements, fee arrangements, perquisites, options, 
post-employment benefits, and other compensatory arrangements. The term 
is defined broadly under the proposed rule in order to include all 
forms of incentive-based compensation.
    The term ``compensation, fees, or benefits'' would exclude 
reimbursement for reasonable and proper costs incurred by covered 
persons in carrying out the covered institution's business.
    Control function. The proposed rule defines ``control function'' as 
a compliance, risk management, internal audit, legal, human resources, 
accounting, financial reporting, or finance role responsible for 
identifying, measuring, monitoring, or controlling risk-taking.\102\ 
The term would include loan review and Bank Secrecy Act roles. Section 
__.9(b) of the proposed rule would require a Level 1 or Level 2 covered 
institution to provide individuals engaged in control functions with 
the authority to influence the risk-taking of the business areas they 
monitor and ensure that covered persons engaged in control functions 
are compensated in accordance with the achievement of performance 
objectives linked to their control functions and independent of the 
performance of the business areas they monitor. As described below, 
section __.11 of the proposed rule would also require that a Level 1 or 
Level 2 covered institution's policies and procedures provide an 
appropriate role for control function personnel in the covered 
institution's incentive-based compensation program. The heads of 
control functions would also be considered senior executive officers 
for purposes of the proposed rule, because such employees can 
individually affect the risk profile of a covered institution.
---------------------------------------------------------------------------

    \102\ The term ``control function'' would serve a different 
purpose than, and is not intended to affect the interpretation of, 
the term ``front line unit,'' as used in the OCC's Heightened 
Standards.
---------------------------------------------------------------------------

    Although covered persons in control functions generally do not 
perform activities designed to generate revenue or reduce expenses, 
they may nonetheless have the ability to expose covered institutions to 
risk of material financial loss. For example, individuals in human 
resources and risk management roles contribute to the design and review 
of performance measures used in incentive-based compensation 
arrangements, which may allow them to influence the activities of risk-
takers in a covered institution. For that reason, the proposed rule 
would treat covered persons who are the heads of control functions as 
senior executive officers who would be subject to certain additional 
requirements under the proposed rule as described further below.
    2.37. The Agencies invite comment on whether and in what 
circumstances, the proposed definition of ``control function'' should 
include additional individuals and organizational units that (a) do not 
engage in activities designed to generate revenue or reduce expenses; 
(b) provide operational support or servicing to any organizational unit 
or function; or (c) provide technology services.
    Deferral. The proposed rule defines ``deferral'' as the delay of 
vesting of incentive-based compensation beyond the date on which the 
incentive-based compensation is awarded. As discussed below in this 
Supplementary Information section, under the proposed

[[Page 37701]]

rule, a Level 1 or Level 2 covered institution would be required to 
defer a portion of the incentive-based compensation of senior executive 
officers and significant risk-takers. The Agencies would not consider 
compensation that has vested, but that the covered person then chooses 
to defer, e.g., for tax reasons, to be deferred incentive-based 
compensation for purposes of the proposed rule because it would not be 
subject to forfeiture.
    The Agencies note that the deferral period under the proposed rule 
would not include any portion of the performance period, even for 
incentive-based compensation plans that have longer performance 
periods. Deferral involves a ``look-back'' period that is intended as a 
stand-alone interval that follows the performance period and allows 
time for ramifications (such as losses or other adverse consequences) 
of, and other information about, risk-taking decisions made during the 
performance period to become apparent.
    If incentive-based compensation is paid in the form of options, the 
period of time between when an option vests and when the option can be 
exercised would not be considered deferral under the proposed rule. As 
with other types of incentive-based compensation, an option would count 
toward the deferral requirement only if it has been awarded but has not 
yet vested, regardless of when the option could be exercised.\103\
---------------------------------------------------------------------------

    \103\ Section __.7(a)(4)(ii) of the proposed rule limits the 
portion of the proposed rule's minimum deferral requirements that 
can be met in the form of options.
---------------------------------------------------------------------------

    2.38. To the extent covered institutions are already deferring 
incentive-based compensation, does the proposed definition of deferral 
reflect current practice? If not, in what way does it differ?
    Deferral period. The proposed rule defines ``deferral period'' as 
the period of time between the date a performance period ends and the 
last date on which the incentive-based compensation that is awarded for 
such performance period vests. A deferral period and a performance 
period that both relate to the same incentive-based compensation award 
could not occur concurrently. Because sections__.7(a)(1)(iii) and 
(a)(2)(iii) of the proposed rule would allow for pro rata vesting of 
deferred amounts during a deferral period, some deferred incentive-
based compensation awarded for a performance period could vest before 
the end of the deferral period following that performance period. As a 
result, the deferral period would be considered to end on the date that 
the last tranche of incentive-based compensation awarded for a 
performance period vests.
    Downward adjustment. The proposed rule defines ``downward 
adjustment'' as a reduction of the amount of a covered person's 
incentive-based compensation not yet awarded for any performance period 
that has already begun, including amounts payable under long-term 
incentive plans, in accordance with a forfeiture and downward 
adjustment review under section __7(b) of the proposed rule. As 
explained above, downward adjustment is distinct from clawback and 
forfeiture because downward adjustment affects incentive-based 
compensation that has not yet been awarded. It is also distinct from 
performance-based adjustments that covered institutions might make in 
determining the amount of incentive-based compensation to award to a 
covered person, absent or separate from a forfeiture or downward 
adjustment review. Depending on the results of a forfeiture and 
downward adjustment review under section __.7(b) of the proposed rule, 
a covered institution could adjust downward incentive-based 
compensation that has not yet been awarded to a senior executive 
officer or significant risk-taker such that the senior executive 
officer or significant risk-taker is awarded none, or only some, of the 
incentive-based compensation that could otherwise have been awarded to 
such senior executive officer or significant risk-taker.
    Equity-like instrument. The proposed rule defines ``equity-like 
instrument'' as (1) equity in the covered institution or of any 
affiliate of the covered institution; or (2) a form of compensation (i) 
payable at least in part based on the price of the shares or other 
equity instruments of the covered institution or of any affiliate of 
the covered institution; or (ii) that requires, or may require, 
settlement in the shares of the covered institution or any affiliate of 
the covered institution. The value of an equity-like instrument would 
be related to the value of the covered institution's shares.\104\ The 
definition includes three categories. Shares are an example of the 
first category, ``equity.'' Examples of the second category, ``a form 
of compensation payable at least in part based on the price of the 
shares or other equity instruments of the covered institution or any 
affiliate of the covered institution,'' include restricted stock units 
(RSUs), stock appreciation rights, and other derivative instruments 
that settle in cash. Examples of the third category, ``a form of 
compensation that requires, or may require, settlement in the shares of 
the covered institution or of any affiliate of the covered 
institution,'' include options and derivative securities that settle, 
either mandatorily or permissively, in shares. An RSU that offers a 
choice of settlement in either cash or shares is also an example of 
this third category. The definition of equity-like instrument would 
include shares in the holding company of a covered institution, or 
instruments the value of which is dependent on the value of shares in 
the holding company of a covered institution. For example, the 
definition would include incentive-based compensation paid in the form 
of shares in a bank holding company, even if that incentive-based 
compensation were provided by a national bank subsidiary of that bank 
holding company. Covered institutions would determine the specific 
terms and conditions of the equity-like instruments they award to 
covered persons.
---------------------------------------------------------------------------

    \104\ The definition of ``equity-like instrument'' in the 
proposed rule is similar to ``share-based payment'' in Topic 718 of 
the Financial Accounting Standards Board (FASB) Accounting Standards 
Codification (formerly FAS 123(R)). Paragraph 718-10-30-20, FASB 
Accounting Standards Codification.
---------------------------------------------------------------------------

    NCUA's proposed rule does not include the definition of ``equity-
like instrument'' because credit unions do not have these types of 
instruments.
    2.39. Are there any financial instruments that are used for 
incentive-based compensation and have a value that is dependent on the 
performance of a covered institution's shares, but are not captured by 
the definition of ``equity-like instrument''? If so, what are they, and 
should such instruments be added to the definition? Why or why not?
    Forfeiture. The proposed rule defines ``forfeiture'' as a reduction 
of the amount of deferred incentive-based compensation awarded to a 
covered person that has not vested.\105\

[[Page 37702]]

Depending on the results of a forfeiture and downward adjustment review 
under section __.7(b) of the proposed rule, a covered institution could 
reduce a significant risk-taker or senior executive officer's unvested 
incentive-based compensation such that none, or only some, of the 
deferred incentive-based compensation vests. As discussed below in this 
Supplementary Information section, a Level 1 or Level 2 covered 
institution would be required to place at risk of forfeiture all 
unvested deferred incentive-based compensation, including amounts that 
have been awarded and deferred under long-term incentive plans.
---------------------------------------------------------------------------

    \105\ Forfeiture is similar to the concept of ``malus'' common 
at some covered institutions. Malus is defined in the CEBS 
Guidelines as ``an arrangement that permits the institution to 
prevent vesting of all or part of the amount of a deferred 
remuneration award in relation to risk outcomes or performance.'' 
See CEBS Guidelines. The 2011 Proposed Rule did not define the term 
``forfeiture,'' but the concept was implicit in the discussion of 
adjustments during the deferral period. See 76 FR at 21179, 
``Deferred payouts may be altered according to risk outcomes either 
formulaically or based on managerial judgment, though extensive use 
of judgment might make it more difficult to execute deferral 
arrangements in a sufficiently predictable fashion to influence the 
risk-taking behavior of a covered person. To be most effective in 
ensuring balance, the deferral period should be sufficiently long to 
allow for the realization of a substantial portion of the risks from 
the covered person's activities, and the measures of loss should be 
clearly explained to covered persons and closely tied to their 
activities during the relevant performance period.''
---------------------------------------------------------------------------

    Incentive-based compensation. The proposed rule defines 
``incentive-based compensation'' as any variable compensation, fees, or 
benefits that serve as an incentive or reward for performance. The 
Agencies propose a broad definition to provide flexibility as forms of 
compensation evolve. Compensation earned under an incentive plan, 
annual bonuses, and discretionary awards are all examples of 
compensation that could be incentive-based compensation. The form of 
payment, whether cash, an equity-like instrument, or any other thing of 
value, would not affect whether compensation, fees, or benefits meet 
the definition of ``incentive-based compensation.''
    In response to a similar definition in the 2011 Proposed Rule, 
commenters asked for clarification about the components of incentive-
based compensation. The proposed definition clarifies that 
compensation, fees, and benefits that are paid for reasons other than 
to induce performance would not be included. For example, compensation, 
fees, or benefits that are awarded solely for, and the payment of which 
is solely tied to, continued employment (e.g., salary or a retention 
award that is conditioned solely on continued employment) would not be 
considered incentive-based compensation. Likewise, payments to new 
employees at the time of hiring (signing or hiring bonuses) that are 
not conditioned on performance achievement would not be considered 
incentive-based compensation because they generally are paid to induce 
a prospective employee to join the institution, not to influence future 
performance of such employee.
    Similarly, a compensation arrangement that provides payments solely 
for achieving or maintaining a professional certification or higher 
level of educational achievement would not be considered incentive-
based compensation under the proposed rule. In addition, the Agencies 
do not intend for this definition to include compensation arrangements 
that are determined based solely on the covered person's level of fixed 
compensation and that do not vary based on one or more performance 
measures (e.g., employer contributions to a 401(k) retirement savings 
plan computed based on a fixed percentage of an employee's salary). 
Neither would the proposed definition include dividends paid and 
appreciation realized on stock or other equity-like instruments that 
are owned outright by a covered person. However, stock or other equity-
like instruments awarded to a covered person under a contract, 
arrangement, plan, or benefit would not be considered owned outright 
while subject to any vesting or deferral arrangement (regardless of 
whether such deferral is mandatory).
    2.40. The Agencies invite comment on the proposed definition of 
incentive-based compensation. Should the definition be modified to 
include additional or fewer forms of compensation and in what way? Is 
the definition sufficiently broad to capture all forms of incentive-
based compensation currently used by covered institutions? Why or why 
not? If not, what forms of incentive-based compensation should be 
included in the definition?
    2.41. The Agencies do not expect that most pensions would meet the 
proposed rule's definition of ``incentive-based compensation'' because 
pensions generally are not conditioned on performance achievement. 
However, it may be possible to design a pension that would meet the 
proposed rule's definition of ``incentive-based compensation.'' The 
Agencies invite comment on whether the proposed rule should contain 
express provisions addressing the status of pensions in relation to the 
definition of ``incentive-based compensation.'' Why or why not?
    Incentive-based compensation arrangement, incentive-based 
compensation plan, and incentive-based compensation program. The 
proposed rule defines three separate, but related, terms describing how 
covered institutions provide incentive-based compensation.\106\ Under 
the proposed rule, ``incentive-based compensation arrangement'' would 
mean an agreement between a covered institution and a covered person, 
under which the covered institution provides incentive-based 
compensation to the covered person, including incentive-based 
compensation delivered through one or more incentive-based compensation 
plans. An individual employment agreement would be an incentive-based 
compensation arrangement.
---------------------------------------------------------------------------

    \106\ The use of these terms under the proposed rule is 
consistent with how the same terms are used in the 2010 Federal 
Banking Agency Guidance.
---------------------------------------------------------------------------

    ``Incentive-based compensation plan'' is defined as a document 
setting forth terms and conditions governing the opportunity for and 
the delivery of incentive-based compensation payments to one or more 
covered persons. An incentive-based compensation plan may cover, among 
other things, specific roles or job functions, categories of 
individuals, or forms of payment. A covered person may be compensated 
under more than one incentive-based compensation plan.
    ``Incentive-based compensation program'' means a covered 
institution's framework for incentive-based compensation that governs 
incentive-based compensation practices and establishes related 
controls. A covered institution's incentive-based compensation program 
would include all of the covered institution's incentive-based 
compensation arrangements and incentive-based compensation plans.
    Long-term incentive plan. The proposed rule defines ``long-term 
incentive plan'' as a plan to provide incentive-based compensation that 
is based on a performance period of at least three years. Any 
incentive-based compensation awarded to a covered person for a 
performance period of less than three years would not be awarded under 
a long-term incentive plan, but instead would be considered 
``qualifying incentive-based compensation'' as that term is defined 
under the proposed rule.\107\
---------------------------------------------------------------------------

    \107\ In the 2011 Proposed Rule, the Agencies did not define the 
term ``long-term incentive plan,'' but the 2011 Proposed Rule 
discussed ``longer performance periods'' as one of four methods used 
to make compensation more sensitive to risk. 76 FR at 21179 (``Under 
this method of making incentive-based compensation risk sensitive, 
the time period covered by the performance measures used in 
determining a covered person's award is extended (for example, from 
one year to two years). Longer performance periods and deferral of 
payment are related in that both methods allow awards or payments to 
be made after some or all risk outcomes associated with a covered 
person's activities are realized or better known.'').
---------------------------------------------------------------------------

    Long-term incentive plans are forward-looking plans designed to 
reward employees for performance over a multi-year period. These plans 
generally provide an award of cash or equity at the end of a 
performance period if the employee meets certain individual or 
institution-wide performance measures. Because they have longer 
performance periods, long-term incentive plans allow more time

[[Page 37703]]

for information about a covered person's performance and risk-taking to 
become apparent, and covered institutions can take that information 
into account to balance risk and reward. Under current practice, the 
performance period for a long-term incentive plan is typically three 
years.\108\
---------------------------------------------------------------------------

    \108\ See Compensation Advisory Partners, ``Large Complex 
Banking Organizations: Trends, Practices, and Outlook'' (June 2012), 
available at http://www.capartners.com/uploads/news/id90/capartners.com-capflash-issue31.pdf; Pearl Meyer & Partners, 
``Trends in Incentive Compensation: How the Federal Reserve is 
Influencing Pay'' (2013), available at https://pearlmeyer.com/pearl/media/pearlmeyer/articles/pmp-art-fedreserveinfluencingpay-so-bankdirector-5-14-2013.pdf; Meridian Compensation Partners, LLC, 
``Executive Compensation in the Banking Industry: Emerging Trends 
and Best Practices, 2014-2015'' (June 22, 2015), available at 
https://www.meridiancp.com/wp-content/uploads/Executive-Compensation-in-the-Banking-Industry.pdf; Compensation Advisory 
Partners, ``Influence of Federal Reserve on Compensation Design in 
Financial Services: An Analysis of Compensation Disclosures of 23 
Large Banking Organizations'' (April 24, 2013), available at http://www.capartners.com/uploads/news/id135/capartners.com-capflash-issue45.pdf; ``The 2014 Top 250 Report: Long-term Incentive Grant 
Practices for Executives'' (``Cook Report'') (October 2014), 
available at http://www.fwcook.com/alert_letters/The_2014_Top_250_Report_Long-Term_Incentive_Grant_Practices_for_Executives.pdf; ``Study of 2013 
Short- and Long-term Incentive Design Criterion Among Top 200 S&P 
500 Companies'' (December 2014), available at http://www.ajg.com/media/1420659/study-of-2013-short-and-long-term-incentive-design-criterion-among-top-200.pdf.
---------------------------------------------------------------------------

    2.42. The Agencies invite comment on whether the proposed 
definition of ``long-term incentive plan'' is appropriate for purposes 
of the proposed rule. Are there incentive-based compensation 
arrangements commonly used by financial institutions that would not be 
included within the definition of ``long-term incentive plan'' under 
the proposed rule but that, given the scope and purposes of section 
956, should be included in such definition? If so, what are the 
features of such incentive-based compensation arrangements, why should 
the definition include such arrangements, and how should the definition 
be modified to include such arrangements?
    Option. The proposed rule defines an ``option'' as an instrument 
through which a covered institution provides a covered person with the 
right, but not the obligation, to buy a specified number of shares 
representing an ownership stake in a company at a predetermined price 
within a set time period or on a date certain, or any similar 
instrument, such as a stock appreciation right. Typically, covered 
persons must wait for a specified time period to conclude before 
obtaining the right to exercise an option.\109\ The definition of 
option would also include option-like instruments that mirror some or 
all of the features of an option. For example, the proposed rule would 
include stock appreciation rights under the definition of option 
because the value of a stock appreciation right is based on a stock's 
price on a future date. As mentioned above, an option would be 
considered an equity-like instrument, as that term is defined in the 
proposed rule. NCUA's proposed rule does not include a definition of 
``option'' because credit unions do not issue options.
---------------------------------------------------------------------------

    \109\ As explained above in the definition of ``deferral,'' the 
time period after the option vests but before it may be exercised is 
not considered part of the deferral period.
---------------------------------------------------------------------------

    Performance period. The proposed rule defines ``performance 
period'' as the period during which the performance of a covered person 
is assessed for purposes of determining incentive-based compensation. 
The Agencies intend for the proposed rule to provide covered 
institutions with flexibility in determining the length and the start 
and end dates of their employees' performance periods. For example, 
under the proposed rule, a covered institution could choose to have a 
performance period that coincided with a calendar year or with the 
covered institution's fiscal year (if the calendar year and fiscal year 
were different). A covered institution could also choose to have a 
performance period of one year for some incentive-based compensation 
and a performance period of three years for other incentive-based 
compensation.
    2.43. Does the proposed rule's definition of ``performance period'' 
meet the goal of providing covered institutions with flexibility in 
determining the length and start and end dates of performance periods? 
Why or why not? Would a prescribed performance period, for example, 
periods that correspond to calendar years, be preferable? Why or why 
not?
    Qualifying incentive-based compensation. The proposed rule defines 
``qualifying incentive-based compensation'' as the amount of incentive-
based compensation awarded to a covered person for a particular 
performance period, excluding amounts awarded to such covered person 
for that particular performance period under a long-term incentive 
plan. With the exception of long-term incentive plans, all forms of 
compensation, fees, and benefits that qualify as ``incentive-based 
compensation,'' including annual bonuses, would be included in the 
amount of qualifying incentive-based compensation. The deferral 
requirements of section __.7(a) of the proposed rule would require a 
Level 1 or Level 2 covered institution to defer a specified percentage 
of any qualifying incentive-based compensation awarded to a significant 
risk-taker or senior executive officer for each performance period.
    Regulatory report. Each Agency has included a definition of 
``regulatory report'' in its version of the proposed rule that explains 
which regulatory reports would be required to be used by each of that 
Agency's covered institutions for the purposes of measuring average 
total consolidated assets under the proposed rule.
    For a national bank, state member bank, state nonmember bank, 
federal savings association, and state savings association, 
``regulatory report'' would mean the consolidated Reports of Condition 
and Income (``Call Report'').\110\ For a U.S. branch or agency of a 
foreign bank, ``regulatory report'' would mean the Reports of Assets 
and Liabilities of U.S. Branches and Agencies of Foreign Banks--FFIEC 
002. For a bank holding company, ``regulatory report'' would mean 
Consolidated Financial Statements for Bank Holding Companies (``FR Y-
9C''). For a savings and loan holding company, ``regulatory report'' 
would mean FR Y-9C; if a savings and loan holding company is not 
required to file an FR Y-9C, Quarterly Savings and Loan Holding Company 
Report (``FR 2320''), if the savings and loan holding company reports 
consolidated assets on the FR 2320. For a savings and loan holding 
company that does not file a regulatory report within the meaning of 
the preceding sentence, ``regulatory report'' would mean a report of 
average total consolidated assets filed with the Board on a quarterly 
basis. For an Edge or Agreement Corporation, ``regulatory report'' 
would mean the Consolidated Report of Condition and Income for Edge and 
Agreement Corporations (``FR 2886b''). For the U.S. operations of a 
foreign banking organization, ``regulatory report'' would mean a report 
of average total consolidated U.S. assets filed with the Board on a 
quarterly basis. For subsidiaries of national banks, Federal savings 
associations, and Federal branches or agencies of foreign banking 
organizations that are not brokers, dealers, persons providing 
insurance, investment companies, or investment advisers, ``regulatory 
report'' would mean a report of the subsidiary's total consolidated 
assets prepared by the subsidiary, national bank, Federal

[[Page 37704]]

savings association, or Federal branch or agency in a form that is 
acceptable to the OCC. For a regulated institution that is a subsidiary 
of a bank holding company, savings and loan holding company, or a 
foreign banking organization, ``regulatory report'' would mean a report 
of the subsidiary's total consolidated assets prepared by the bank 
holding company, savings and loan holding company, or subsidiary in a 
form that is acceptable to the Board.
---------------------------------------------------------------------------

    \110\ Specifically, the OCC will refer to item RCFD 2170 of 
Schedule RC.
---------------------------------------------------------------------------

    For FHFA's proposed rule, ``regulatory report'' would mean the Call 
Report Statement of Condition.
    For a natural person credit union, ``regulatory report'' would mean 
the 5300 Call Report. For corporate credit unions, ``regulatory 
report'' would mean the 5310 Call Report.
    For a broker or dealer registered under section 15 of the 
Securities Exchange Act of 1934 (15 U.S.C. 78o), ``regulatory report'' 
would mean the FOCUS Report.\111\ For an investment adviser, as such 
term is defined in section 202(a)(11) of the Investment Advisers Act, 
and as discussed above, total consolidated assets would be determined 
by the investment adviser's total assets (exclusive of non-proprietary 
assets) shown on the balance sheet for the adviser's most recent fiscal 
year end.\112\
---------------------------------------------------------------------------

    \111\ 17 CFR 240.17a-5(a); 17 CFR 249.617.
    \112\ The proposed rule would not apply the concept of a 
regulatory report and the attendant mechanics provided in section 
__.3 of the proposed rule to covered institutions that are 
investment advisers because such institutions are not currently 
required to report the amount of total consolidated assets to any 
Federal regulators in their capacities as investment advisers. See 
proposed definition of ``average total consolidated assets'' for the 
proposed method by which an investment adviser would determine its 
asset level for purposes of the proposed rule.
---------------------------------------------------------------------------

    Vesting. Under the proposed rule, ``vesting'' of incentive-based 
compensation means the transfer of ownership \113\ of the incentive-
based compensation to the covered person to whom the incentive-based 
compensation was awarded, such that the covered person's right to the 
incentive-based compensation is no longer contingent on the occurrence 
of any event. Amounts awarded under an incentive-based compensation 
arrangement may vest immediately--for example, when the amounts are 
paid out to a covered person immediately and are not subject to 
deferral and forfeiture. As explained above, before amounts awarded to 
a covered person vest, the amounts could also be deferred and at risk 
of forfeiture. After amounts awarded to a covered person vest, the 
amounts could be subject to clawback, but they would not be at risk of 
forfeiture.
---------------------------------------------------------------------------

    \113\ Compensation awarded to a trust or other entity at the 
direction of, or for the benefit of, a covered person would be 
treated as compensation awarded to that covered person. If 
incentive-based compensation awarded to the entity cannot be reduced 
by forfeiture, the amounts would be treated as having vested at the 
time of the award.
---------------------------------------------------------------------------

    As described below in this SUPPLEMENTARY INFORMATION section, for 
incentive-based compensation to be counted toward the minimum deferral 
amount as discussed in section __.7(a) of the proposed rule, a 
sufficient amount of time must elapse between the end of the 
performance period and the time when the deferred incentive-based 
compensation vests (and is no longer subject to forfeiture). During 
that deferral period, the award would be at risk of forfeiture.
    If, after the award date, the covered institution had the right to 
require forfeiture of the shares or units awarded, then the award would 
not be considered vested. If, after the award date, the covered 
institution does not have the right to require forfeiture of the shares 
or units awarded, then the award would be vested and therefore would 
not be able to be counted toward the minimum deferral amount even if 
the shares or units have not yet been transferred to the covered 
person. For example, a covered institution could award an employee 100 
shares of stock appreciation rights that pay out five years after the 
award date. In other words, five years after the award date, the 
covered institution will pay the employee the difference between the 
value of 100 shares of the covered institution's stock on the award 
date and the value of 100 shares of the covered institution's stock 
five years later. The amount the covered institution pays the employee 
could vary based on the value of the institution's shares. If the 
covered institution does not have the right to adjust the number of 
shares of stock appreciation rights before the payout, the stock 
appreciation rights would be considered vested as of the award date 
(even if the amount paid out could vary based on the value of the 
institution's shares). If, however, the covered institution has the 
right to adjust the number of shares of stock appreciation rights until 
payout to account for risk outcomes that occur after the award date 
(for example, by reducing the number of shares of stock appreciation 
rights from 100 to 50 based on a failure to comply with the 
institution's risk management policies), the stock appreciation rights 
would not be considered vested until payout. Similarly, amounts paid to 
a covered person pursuant to a dividend equivalent right would vest 
when the number of dividend equivalent rights cannot be adjusted by the 
covered institution on the basis of risk outcomes.
    2.44. The Agencies invite comment generally on the proposed rule's 
definitions.
Relationship Between Defined Terms
    The relationship between some of these defined terms can best be 
explained chronologically. Under the proposed rule, a covered 
institution's incentive-based compensation timeline would be as 
follows:
     Performance period. A covered person may have incentive-
based compensation targets based on performance measures that would 
apply during a performance period. A covered person's performance or 
the performance of the covered institution during this period would 
influence the amount of incentive-based compensation awarded to the 
covered person. Before incentive-based compensation is awarded to a 
covered person, it should be subject to risk adjustments to reflect 
actual losses, inappropriate risks taken, compliance deficiencies, or 
other measures or aspects of financial and non-financial performance, 
as described in section __.4(d) of the proposed rule. In addition, at 
any time during the performance period, incentive-based compensation 
could be subject to downward adjustment, as described in section 
__.7(b) of the proposed rule.
     Downward adjustment (if needed). Downward adjustment could 
occur at any time during a performance period if a Level 1 or Level 2 
covered institution conducts a forfeiture and downward adjustment 
review under section __.7(b) of the proposed rule and the Level 1 or 
Level 2 covered institution determines that incentive-based 
compensation not yet awarded for the current performance period should 
be reduced. In other words, downward adjustment applies to plans where 
the performance period has not yet ended.
     Award. At or near the end of a performance period, a 
covered institution would evaluate the covered person's or 
institution's performance, taking into account adjustments described in 
section __.4(d)(3) of the proposed rule, and determine the amount of 
incentive-based compensation, if any, to be awarded to the covered 
person for that performance period. At that time, the covered 
institution would determine what portion of the incentive-based 
compensation that is awarded will be deferred, as well as the vesting 
schedule for that deferred incentive-based compensation. A Level 1 or 
Level 2

[[Page 37705]]

covered institution could reduce the amount of incentive-based 
compensation payable to a senior executive officer or significant risk-
taker depending on the outcome of a forfeiture and downward adjustment 
review, as described in section __.7(b) of the proposed rule.
     Deferral period. The deferral period for incentive-based 
compensation awarded for a particular performance period would begin at 
the end of such performance period, regardless of when a covered 
institution awards incentive-based compensation to a covered person for 
that performance period. At any time during a deferral period, a 
covered institution could require forfeiture of some or all of the 
incentive-based compensation that has been awarded to the covered 
person but has not yet vested.
     Forfeiture (if needed). Forfeiture could occur at any time 
during the deferral period (after incentive-based compensation has been 
awarded but before it vests). A Level 1 or Level 2 covered institution 
could require forfeiture of unvested deferred incentive-based 
compensation payable to a senior executive officer or significant risk-
taker based on the result of a forfeiture and downward adjustment 
review, as described in section __.7(b) of the proposed rule. Depending 
on the outcome of a forfeiture and downward adjustment review under 
section __.7(b) of the proposed rule, a covered institution could 
reduce, or eliminate, the unvested deferred incentive-based 
compensation of a senior executive officer or significant risk-taker.
     Vesting. Vesting could occur annually, on a pro rata 
basis, throughout a deferral period. Vesting could also occur at a 
slower than pro rata schedule, such as entirely at the end of a 
deferral period (vesting entirely at the end of a deferral period is 
sometimes called ``cliff vesting''). The deferral period for a 
particular performance period would end when all incentive-based 
compensation awarded for that performance period has vested. A covered 
institution may also evaluate information that has arisen over the 
deferral period about financial losses, inappropriate risks taken, 
compliance deficiencies, or other measures or aspects of financial and 
non-financial performance of the covered person at the time of vesting 
to determine if the amount that has been deferred should vest in full 
or should be reduced through forfeiture.
     Clawback (if needed). Clawback could be used to recover 
incentive-based compensation that has already vested. Clawback could be 
used after a deferral period has ended, and it also could be used to 
recover any portion of incentive-based compensation that vests before 
the end of a deferral period. A Level 1 or Level 2 covered institution 
would be required to include clawback provisions in incentive-based 
compensation arrangements for senior executive officers and significant 
risk-takers, as described in section __.7(c) of the proposed rule.
    2.45. Is the interplay of the award date, vesting date, performance 
period, and deferral period clear? If not, why not?
    2.46. Have the Agencies made clear the distinction between the 
proposed definitions of clawback, forfeiture, and downward adjustment? 
Do these definitions align with current industry practice? If not, in 
what way do they differ and what are the implications of such 
differences for both the operations of covered institutions and the 
effective supervision of compensation practices?

Sec.  __.3 Applicability

    Section __.3 describes which provisions of the proposed rule would 
apply to an institution that is subject to the proposed rule when an 
increase or decrease in average total consolidated assets causes it to 
become a covered institution, transition to another level, or no longer 
meet the definition of covered institution. This process may differ 
somewhat depending on whether the institution is a subsidiary of, or 
affiliated with, another covered institution.
    As discussed above, for an institution that is not an investment 
adviser, average total consolidated assets would be determined by 
reference to the average of the total consolidated assets reported on 
regulatory reports for the four most recent consecutive quarters. The 
Agencies are proposing this calculation method because it is also used 
to calculate total consolidated assets for purposes of other rules that 
have $50 billion thresholds,\114\ and it is therefore expected to 
result in lower administrative burden on some institutions--
particularly when those institutions move from Level 3 to Level 2--if 
the proposed rule requires total consolidated assets to be calculated 
in the same way as existing rules.
---------------------------------------------------------------------------

    \114\ See, e.g., OCC's Heightened Standards; 12 CFR 46.3; 12 CFR 
225.8; 12 CFR 243.2; 12 CFR 252.30; 2 CFR 252.132; 12 CFR 325.202; 
12 CFR 381.2.
---------------------------------------------------------------------------

    As discussed above, average total consolidated assets for a covered 
institution that is an investment adviser would be determined by the 
investment adviser's total assets (exclusive of non-proprietary assets) 
shown on the balance sheet for the adviser's most recent fiscal year 
end. The proposed rule would not apply the concept of a regulatory 
report and the attendant mechanics provided in section __.3 of the 
proposed rule to covered institutions that are investment advisers 
because such institutions are not currently required to report the 
amount of total consolidated assets to any Federal regulators in their 
capacities as investment advisers.
(a) When Average Total Consolidated Assets Increase
    Section __.3(a) of the proposed rule describes how the proposed 
rule would apply to institutions that are subject to the proposed rule 
when average total consolidated assets increase. It generally provides 
that an institution that is not a subsidiary of another covered 
institution becomes a Level 1, Level 2, or Level 3 covered institution 
when its average total consolidated assets increase to an amount that 
equals or exceeds $250 billion, $50 billion, or $1 billion, 
respectively. For subsidiaries of other covered institutions, the 
Agencies would generally look to the average total consolidated assets 
of the top-tier parent holding company to determine whether average 
total consolidated assets have increased.
    Given the unique characteristics of the different types of covered 
institutions subject to each Agency's proposed rule, each Agency's 
proposed rule contains specific language for subsidiaries that is 
consistent with the same general approach. For example, under the 
Board's proposed rule, a regulated institution would become a Level 1, 
Level 2, or Level 3 covered institution when its average total 
consolidated assets or the average total consolidated assets of any of 
its affiliates, equals or exceeds $250 billion, $50 billion, or $1 
billion, respectively. Under the OCC's proposed rule, a national bank 
that is a subsidiary of a bank holding company would become a Level 1, 
Level 2, or Level 3 covered institution when the top-tier bank holding 
company's average total consolidated assets equals or exceeds $250 
billion, $50 billion, or $1 billion, respectively. Because the Federal 
Home Loan Banks have no subsidiaries, and subsidiaries of the 
Enterprises are included as affiliates as part of the definition of the 
Enterprises, FHFA's proposed rule does not include specific language to 
address subsidiaries. Because the NCUA's rule does not cover 
subsidiaries of credit unions and credit unions are not subsidiaries of 
other types of institutions, NCUA's proposed

[[Page 37706]]

rule does not include specific language to address subsidiaries. More 
detail on each Agency's proposed approach to subsidiaries is provided 
in the above discussion of definitions relating to covered 
institutions.
    For covered institutions other than investment advisers and the 
Federal Home Loan Banks, using a rolling average for asset size, rather 
than measuring asset size at a single point in time, should minimize 
the frequency with which an institution may fall into or out of a 
covered institution level. As explained above, if a covered institution 
has fewer than four regulatory reports, the institution would be 
required to use the average of its total consolidated assets from its 
existing regulatory reports for purposes of determining average total 
consolidated assets. If a covered institution has a mix of two or more 
different types of regulatory reports covering the relevant period, 
those would be averaged for purposes of determining average total 
consolidated assets.
    Section __.3(a)(2) of the proposed rule provides a transition 
period for institutions that were not previously considered covered 
institutions and for covered institutions moving from a lower level to 
a higher level due to an increase in average total consolidated assets. 
Such covered institutions would be required to comply with the 
requirements for their new level not later than the first day of the 
first calendar quarter that begins at least 540 days after the date on 
which they become Level 1, Level 2, or Level 3 covered institutions. 
Prior to such date, the institutions would be required to comply with 
the requirements of the proposed rule, if any, that were applicable to 
them on the day before they became Level 1, Level 2, or Level 3 covered 
institutions as a result of the increase in assets. For example, if a 
Level 3 covered institution that is not a subsidiary of a depository 
institution holding company has average total consolidated assets that 
increase to more than $50 billion on December 31, 2015, then such 
institution would become a Level 2 covered institution on December 31, 
2015. However, the institution would not be required to comply with the 
requirements of the proposed rule that are applicable to a Level 2 
covered institution until July 1, 2017. Prior to July 1, 2017, (the 
compliance date), the institution would remain subject to the 
requirements of the proposed rule that are applicable to a Level 3 
covered institution. The covered institution's controls, risk 
management, and corporate governance also would be required to comply 
with the provisions of the proposed rule that are applicable to a Level 
2 covered institution no later than July 1, 2017. The Agencies are 
proposing this delay between the date when a covered institution's 
average total consolidated assets increase and the date when the 
covered institution becomes subject to the requirements related to its 
new level to provide covered institutions with sufficient time to 
comply with the new requirements.
    The same general rule would apply to covered institutions that are 
subsidiaries (or, in the case of the Board's proposed rule, affiliates) 
of other covered institutions. For example, a Level 3 state savings 
association that is a subsidiary of a Level 3 savings and loan holding 
company, and a Level 3 subsidiary of that state savings association, 
would become a Level 2 covered institution on December 31, 2015, if the 
average total consolidated assets of the savings and loan holding 
company increased to more than $50 billion on December 31, 2015, and 
would not be required to comply with the requirements of the proposed 
rule that are applicable to a Level 2 covered institution until July 1, 
2017.
    Section __.3(a)(3) of the proposed rule provides that incentive-
based compensation plans with performance periods that begin before the 
compliance date described in section __.3(a)(2) would not be required 
to comply with the requirements of the proposed rule that become 
applicable to the covered institution on the compliance date as a 
result of the change in its status as a Level 1, Level 2, or Level 3 
covered institution. Incentive-based compensation plans with a 
performance period that begins on or after the compliance date 
described in section __.3(a)(2) would be required to comply with the 
rules for the covered institution's new level. In the example described 
in the previous paragraph, any incentive-based compensation plan with a 
performance period that begins before July 1, 2017, would not be 
required to comply with the requirements of the proposed rule that are 
applicable to a Level 2 covered institution (although any such plan 
would be required to comply with the requirements of the proposed rule 
that are applicable to a Level 3 covered institution).
    The Agencies have included this grandfathering provision so that 
covered institutions would not be required to modify incentive-based 
compensation plans that are already in place when a covered 
institution's average total consolidated assets increase such that it 
moves to a higher level. However, incentive-based compensation plans 
with performance periods that begin after the compliance date would be 
subject to the rules that apply to the covered institution's new level. 
In the previous example, any incentive-based compensation plan for a 
senior executive officer with a performance period that begins on or 
after July 1, 2017, would be required to comply with the requirements 
of the proposed rule that are applicable to a Level 2 covered 
institution, such as the deferral, forfeiture, downward adjustment, and 
clawback requirements contained in section __.7 of the proposed rule.
    Because institutions that would be covered institutions under the 
proposed rule commonly use long-term incentive plans with overlapping 
performance periods or incentive-based compensation plans with 
performance periods of one year, the Agencies do not anticipate that 
the grandfathering provision would unduly delay the application of the 
proposed rule to individual incentive-based compensation arrangements.
    3.1. The Agencies invite comment on whether a covered institution's 
average total consolidated assets (a rolling average) is appropriate 
for determining a covered institution's level when its total 
consolidated assets increase. Why or why not? Will 540 days provide 
covered institutions with adequate time to adjust incentive-based 
compensation programs to comply with different requirements? If not, 
why not? In the alternative, is 540 days too long to give covered 
institutions time to comply with the requirements of the proposed rule? 
Why or why not?
    3.2. The Agencies invite comment on whether the date described in 
section __.3(a)(2) should instead be the beginning of the first 
performance period that begins at least 365 days after the date on 
which the regulated institution becomes a Level 1, Level 2, or Level 3 
covered institution in order to have the date on which the proposed 
rule's corporate governance, policies, and procedures requirements 
begin coincide with the date on which the requirements applicable to 
plans begin. Why or why not?
(b) When Total Consolidated Assets Decrease
    Section __.3(b) of the proposed rule describes how the proposed 
rule would apply to an institution when assets decrease. A covered 
institution (other than an investment adviser) that is not a subsidiary 
of another covered institution would cease to be a Level 1, Level 2, or 
Level 3 covered institution

[[Page 37707]]

if its total consolidated assets, as reported on its regulatory 
reports, fell below the relevant total consolidated assets threshold 
for Level 1, Level 2, or Level 3 covered institutions, respectively, 
for four consecutive quarters. The calculation would be effective on 
the as-of date of the fourth consecutive regulatory report. For 
example, a bank holding company that is a Level 2 covered institution 
with total consolidated assets of $55 billion on January 1, 2016, might 
report total consolidated assets of $48 billion for the first quarter 
of 2016, $49 billion for the second quarter of 2016, $49 billion for 
the third quarter of 2016, and $48 billion for the fourth quarter of 
2016. On the as-of date of the Y-9C submitted for the fourth quarter of 
2016, that bank holding company would become a Level 3 covered 
institution because its total consolidated assets were less than $50 
billion for four consecutive quarters. In contrast, if that same bank 
holding company reported total consolidated assets of $48 billion for 
the first quarter of 2016, $49 billion for the second quarter of 2016, 
$49 billion for the third quarter of 2016, and $51 billion for the 
fourth quarter of 2016, it would still be considered a Level 2 covered 
institution on the as-of date of the Y-9C submitted for the fourth 
quarter of 2016 because it had total consolidated assets of less than 
$50 billion for only 3 consecutive quarters. If the bank holding 
company had total consolidated assets of $49 billion in the first 
quarter of 2017, it still would not become a Level 3 covered 
institution at that time because it would not have four consecutive 
quarters of total consolidated assets of less than $50 billion. The 
bank holding company would only become a Level 3 covered institution if 
it had four consecutive quarters with total consolidated assets of less 
than $50 billion after the fourth quarter of 2016.
    As with section __.3(a), a Level 1, Level 2, or Level 3 covered 
institution that is a subsidiary of another Level 1, Level 2, or Level 
3 covered institution would cease to be a Level 1, Level 2, or Level 3 
covered institution when the top-tier parent covered institution ceases 
to be a Level 1, Level 2, or Level 3 covered institution. As with 
section __.3(a), each Agency's proposed rule takes a slightly different 
approach that is consistent with the same general principle. For 
example, if a broker-dealer with less than $50 billion in average total 
consolidated assets is a Level 2 covered institution because its parent 
bank holding company has more than $50 billion in average total 
consolidated assets, the broker-dealer would become a Level 3 covered 
institution if its parent bank holding company had less than $50 
billion in total consolidated assets for four consecutive quarters, 
thus causing the parent bank holding company itself to become a Level 3 
covered institution.
    The proposed rule would not require any transition period when a 
decrease in a covered institution's total consolidated assets causes it 
to become a Level 2 or Level 3 covered institution or to no longer be a 
covered institution. The Agencies are not proposing to include a 
transition period in this case because the new requirements would be 
less stringent than the requirements that were applicable to the 
covered institution before its total consolidated assets decreased, and 
therefore a transition period should be unnecessary. Instead, the 
covered institution would immediately be subject to the provisions of 
the proposed rule, if any, that are applicable to it as a result of the 
decrease in its total consolidated assets. For example, if as a result 
of having four consecutive regulatory reports with total consolidated 
assets less than $50 billion, a bank holding company that was 
previously a Level 2 covered institution becomes a Level 3 covered 
institution as of June 30, 2017, then as of June 30, 2017 that bank 
holding company would no longer be subject to the requirements of the 
proposed rule that are applicable to Level 2 covered institutions. It 
would instead be subject to the requirements of the proposed rule that 
are applicable to Level 3 covered institutions.
    A covered institution that is an investment adviser would cease to 
be a Level 1, Level 2, or Level 3 covered institution effective as of 
the most recent fiscal year end in which its total consolidated assets 
fell below the relevant asset threshold for Level 1, Level 2, or Level 
3 covered institutions, respectively. For example, an investment 
adviser that is a Level 1 covered institution during 2015 would cease 
to be a Level 1 covered institution effective on December 31, 2015 if 
its total assets (exclusive of non-proprietary assets) shown on its 
balance sheet for the year ended December 31, 2015 (assuming the 
investment adviser had a calendar fiscal year) were less than $250 
billion.
    3.3. The Agencies invite comment on whether four consecutive 
quarters is an appropriate period for determining a covered 
institution's level when its total consolidated assets decrease. Why or 
why not?
    3.4. Should the determination of total consolidated assets for 
covered institutions that are investment advisers be by reference to a 
periodic report or similar concept? Why or why not? Should there be a 
concept of a rolling average for asset size for covered institutions 
that are investment advisers and, if so, how should this be structured?
    3.5. Should the transition period for an institution that changes 
levels or becomes a covered institution due to a merger or acquisition 
be different than an institution that changes levels or becomes a 
covered institution without a change in corporate structure? If so, 
why? If so, what transition period would be appropriate and why?
    3.6. The Agencies invite comment on whether covered institutions 
transitioning from Level 1 to Level 2 or Level 2 to Level 3 should be 
permitted to modify incentive-based compensation plans with performance 
periods that began prior to their transition in level in such a way 
that would cause the plans not to meet the requirements of the proposed 
rule that were applicable to the covered institution at the time when 
the performance periods for the plans commenced. Why or why not?
(c) Compliance of Covered Institutions That Are Subsidiaries of Covered 
Institutions
    Section __.3(c) of the Board's, OCC's, or FDIC's proposed rules 
provide that a covered institution that is subject to the Board's, 
OCC's, or FDIC's proposed rule, respectively, and that is a subsidiary 
of another covered institution may meet any requirement of the proposed 
rule if the parent covered institution complies with such requirement 
in a way that causes the relevant portion of the incentive-based 
compensation program of the subsidiary covered institution to comply 
with the requirement. The Board, the OCC, and the FDIC have included 
this provision in their proposed rules in order to reduce the 
compliance burden on subsidiaries that would be subject to the Board's, 
OCC's, and FDIC's proposed rules and in recognition of the fact that 
holding companies, national banks, Federal savings associations, state 
nonmember banks, and state savings associations may perform certain 
functions on behalf of such subsidiaries.
    Subsidiary covered institutions subject to the Board's, OCC's, or 
FDIC's proposed rule could rely on this provision to comply with, for 
example, the corporate governance or policies and procedures 
requirements of the proposed rule. For example, if a parent bank 
holding company has a compensation committee that performs the 
requirements of section __.4(e) of

[[Page 37708]]

the proposed rule with respect to a subsidiary of the parent bank 
holding company that is a covered institution under the Board's rule by 
(1) conducting oversight of the subsidiary's incentive-based 
compensation program, (2) approving incentive-based compensation 
arrangements for senior executive officers of the subsidiary (including 
any individuals who are senior executive officers of the subsidiary but 
not senior executive officers of the parent bank holding company), and 
(3) approving any material exceptions or adjustments to incentive-based 
compensation policies or arrangements for such senior executive 
officers of the subsidiary, then the subsidiary would be deemed to have 
complied with the requirements of section __.4(e) of the proposed rule. 
Similarly, under the OCC's proposed rule, if an operating subsidiary of 
a national bank that is a Level 1 or Level 2 covered institution 
subject to the OCC's proposed rule uses the policies and procedures for 
its incentive-based compensation program of its parent national bank 
that is also a Level 1 or Level 2 covered institution subject to the 
OCC's proposed rule, and such policies and procedures satisfy the 
requirements of section __.11 of the proposed rule, then the OCC would 
consider the subsidiary to have satisfied section __.11 of the proposed 
rule. Under the FDIC's proposed rule, if a subsidiary of a state 
nonmember bank or state savings association that is a covered 
institution subject to the FDIC's proposed rule uses the policies and 
procedures for its incentive-based compensation program of its parent 
state nonmember bank or state savings association that is a Level 1 or 
Level 2 covered institution subject to the FDIC's proposed rule, and 
such policies and procedures satisfy the requirements of section __.11 
of the proposed rule, then the FDIC would consider the subsidiary to 
have satisfied section __.11 of the proposed rule.
    Many parent holding companies, particularly larger banking 
organizations, design and administer incentive-based compensation 
programs and associated policies and procedures. Smaller covered 
institutions that operate within a larger holding company structure may 
realize efficiencies by incorporating or relying upon their parent 
company's incentive-based compensation program or certain components of 
the program, to the extent that the program or its components establish 
governance, risk management, and recordkeeping frameworks that are 
appropriate to the smaller covered institutions and support incentive-
based compensation arrangements that appropriately balance risks to the 
smaller covered institution and rewards for its covered persons. 
Therefore, it may be less burdensome for covered institution 
subsidiaries with risk profiles that are similar to those of their 
parent holding companies to use their parent holding companies' program 
rather than their own.
    The Agencies recognize that the authority of each appropriate 
Federal regulator to examine and review compliance with the proposed 
rule, along with requiring corrective action when they deem 
appropriate, would not be affected by section __.3(c) of the Board's, 
OCC's, or FDIC's proposed rule. Each appropriate Federal regulator 
would be responsible for examining, reviewing, and enforcing compliance 
with the proposed rule by their covered institutions, including any 
that are owned or controlled by a depository institution holding 
company. For example, in the situation where a parent holding company 
controls a subsidiary national bank, state nonmember bank, or broker-
dealer, it would be expected that the board of directors of the 
subsidiary will ensure that the subsidiary is in compliance with the 
proposed rule. Likewise, the board of directors of a broker-dealer 
operating subsidiary of a national bank would be expected to ensure 
that the broker-dealer operating subsidiary is in compliance with the 
proposed rule.

Sec.  __.4 Requirements and Prohibitions Applicable to All Covered 
Institutions

    Section __.4 sets forth the general requirements that would be 
applicable to all covered institutions. Later sections establish more 
specific requirements that would be applicable for Level 1 and Level 2 
covered institutions.
    Under the proposed rule, all covered institutions would be 
prohibited from establishing or maintaining incentive-based 
compensation arrangements, or any features of any such arrangements, 
that encourage inappropriate risks by the covered institution (1) by 
providing covered persons with excessive compensation, fees, or 
benefits or (2) that could lead to material financial loss to the 
covered institution. Section __.4 includes considerations for 
determining whether an incentive-based compensation arrangement 
provides excessive compensation, fees, or benefits, as required by 
section 956(a)(1). Section __.4 also establishes requirements that 
would apply to all covered institutions designed to prevent 
inappropriate risks that could lead to material financial loss, as 
required by section 956(a)(2).\115\ The general standards and 
requirements set forth in sections __.4(a), (b), and (c) of the 
proposed rule would be consistent with the general standards and 
requirements set forth in sections __.5(a) and (b) of the 2011 Proposed 
Rule.
---------------------------------------------------------------------------

    \115\ In addition to the requirements outlined in section __.4, 
Level 1 and Level 2 covered institutions would have to meet 
additional requirements set forth in section __.5 and sections __.7 
through __.11.
---------------------------------------------------------------------------

    The Agencies do not intend to establish a rigid, one-size-fits-all 
approach to the design of incentive-based compensation arrangements. 
Thus, under the proposed rule, the structure of incentive-based 
compensation arrangements at covered institutions would be expected to 
reflect the proposed requirements set forth in section __.4 of the 
proposed rule in a manner tailored to the size, complexity, risk 
tolerance, and business model of the covered institution. Subject to 
supervisory oversight, as applicable, each covered institution would be 
responsible for ensuring that its incentive-based compensation 
arrangements appropriately balance risk and reward. The methods by 
which this is achieved at one covered institution may not be effective 
at another, in part because of the importance of integrating incentive-
based compensation arrangements and practices into the covered 
institution's own risk-management systems and business model. The 
effectiveness of methods may differ across business lines and operating 
units as well, so the proposed rule would provide for considerable 
flexibility in how individual covered institutions approach the design 
and implementation of incentive-based compensation arrangements that 
appropriately balance risk and reward.
(a) In General
    Section __.4(a) of the proposed rule is derived from the text of 
section 956(b) which requires the Agencies to jointly prescribe 
regulations or guidelines that prohibit any type of incentive-based 
payment arrangement, or any feature of any such arrangement, that the 
Agencies determine encourages inappropriate risks by covered 
institutions (1) by providing an executive officer, employee, director, 
or principal shareholder of the covered institution with excessive 
compensation, fees, or benefits or (2) that could lead to material 
financial loss to the covered institution.
(b) Excessive Compensation
    Section __.4(b) of the proposed rule specifies that compensation, 
fees, and

[[Page 37709]]

benefits would be considered excessive for purposes of section 
__.4(a)(1) when amounts paid are unreasonable or disproportionate to 
the value of the services performed by a covered person, taking into 
account all relevant factors. Section 956(c) directs the Agencies to 
``ensure that any standards for compensation established under 
subsections (a) or (b) are comparable to the standards established 
under section [39] of the Federal Deposit Insurance Act (12 U.S.C. 2 
[sic] 1831p-1) for insured depository institutions.'' Under the 
proposed rule, the factors for determining whether an incentive-based 
compensation arrangement provides excessive compensation would be 
comparable to the Federal Banking Agency Safety and Soundness 
Guidelines that implement the requirements of section 39 of the 
FDIA.\116\ The proposed factors would include: (1) The combined value 
of all compensation, fees, or benefits provided to the covered person; 
(2) the compensation history of the covered person and other 
individuals with comparable expertise at the covered institution; (3) 
the financial condition of the covered institution; (4) compensation 
practices at comparable covered institutions, based upon such factors 
as asset size, geographic location, and the complexity of the covered 
institution's operations and assets; (5) for post-employment benefits, 
the projected total cost and benefit to the covered institution; and 
(6) any connection between the covered person and any fraudulent act or 
omission, breach of trust or fiduciary duty, or insider abuse with 
regard to the covered institution. The inclusion of these factors is 
consistent with the requirement under section 956(c) that any standards 
for compensation under section 956(a) or (b) must be comparable to the 
standards established for insured depository institutions under the 
FDIA and that the Agencies must take into consideration the 
compensation standards described in section 39(c) of the FDIA.
---------------------------------------------------------------------------

    \116\ The Federal Banking Agency Safety and Soundness Guidelines 
provide: Compensation shall be considered excessive when amounts 
paid are unreasonable or disproportionate to the services performed 
by an executive officer, employee, director, or principal 
shareholder, considering the following: (1) The combined value of 
all cash and non-cash benefits provided to the individual; (2) The 
compensation history of the individual and other individuals with 
comparable expertise at the institution; (3) The financial condition 
of the institution; (4) Comparable compensation practices at 
comparable institutions, based upon such factors as asset size, 
geographic location, and the complexity of the loan portfolio or 
other assets; (5) For postemployment benefits, the projected total 
cost and benefit to the institution; (6) Any connection between the 
individual and any fraudulent act or omission, breach of trust or 
fiduciary duty, or insider abuse with regard to the institution; and 
(7) Any other factors the Agencies determines to be relevant. See 12 
CFR part 30, Appendix A, III.A; 12 CFR part 364, Appendix A, III.A; 
12 CFR part 208, Appendix D-1. These factors are drawn directly from 
section 39(c)(2) of the FDIA (12 U.S.C. 1831p-1(c)(2)).
---------------------------------------------------------------------------

    In response to similar language in the 2011 Proposed Rule, some 
commenters indicated that this list of factors should include 
additional factors or allow covered institutions to consider other 
factors that they deem appropriate. The proposed rule clarifies that 
all relevant factors would be taken into consideration, and that the 
list of factors in section __.4(b) would not be exclusive.
    Commenters on the 2011 Proposed Rule expressed concern that it 
would be difficult for some types of institutions, such as 
grandfathered unitary savings and loan holding companies with retail 
operations, mutual savings associations, mutual savings banks, and 
mutual holding companies, to identify comparable covered institutions. 
Those commenters also expressed concern that it would be difficult for 
these institutions to identify the compensation practices of comparable 
institutions that are not public companies or that do not otherwise 
make public information about their compensation practices. The 
Agencies intend to work closely with these institutions to identify 
comparable institutions to help ensure compliance with the proposed 
rule.
(c) Material Financial Loss
    Section 956(b)(2) of the Act requires the Agencies to adopt 
regulations or guidelines that prohibit any type of incentive-based 
payment arrangement, or any feature of any such arrangement, that the 
Agencies determine encourages inappropriate risks by a covered 
financial institution that could lead to material financial loss to the 
covered institution. In adopting such regulations or guidelines, the 
Agencies are required to ensure that any standards established under 
this provision of section 956 are comparable to the standards under 
Section 39 of the FDIA, including the compensation standards. However, 
section 39 of the FDIA does not include standards for determining 
whether compensation arrangements may encourage inappropriate risks 
that could lead to material financial loss.\117\ Accordingly, as in the 
2011 Proposed Rule, the Agencies have considered the language and 
purpose of section 956, existing supervisory guidance that addresses 
incentive-based compensation arrangements that may encourage 
inappropriate risk-taking,\118\ the FSB Principles and Implementation 
Standards, and other relevant material in considering how to implement 
this aspect of section 956.
---------------------------------------------------------------------------

    \117\ Section 39 of the FDIA requires only that the Federal 
banking agencies prohibit as an unsafe and unsound practice any 
employment contract, compensation or benefit agreement, fee 
arrangement, perquisite, stock option plan, postemployment benefit, 
or other compensatory arrangement that could lead to a material 
financial loss. See 12 U.S.C. 1831p-1(c)(1)(B). The Federal Banking 
Agency Safety and Soundness Guidelines satisfy this requirement.
    \118\ 2010 Federal Banking Agency Guidance.
---------------------------------------------------------------------------

    A commenter argued that the provisions of the 2011 Proposed Rule 
relating to incentive-based compensation arrangements that could 
encourage inappropriate risks that could lead to material financial 
loss were not comparable to the standards established under section 39 
of the FDIA. More specifically, the commenter believed that the 
requirements of the 2011 Proposed Rule, including the mandatory 
deferral requirement, were more ``detailed and prescriptive'' than the 
standards established under section 39 of the FDIA.
    The Agencies intend that the requirements of the proposed rule 
implementing section 956(b)(2) of the Act would be comparable to the 
standards established under section 39 of the FDIA. Section 956(b)(2) 
of the Act requires that the Agencies prohibit incentive-based 
compensation arrangements that encourage inappropriate risks by covered 
institutions that could lead to material financial loss, a requirement 
that is not discussed in the standards established under section 39 of 
the FDIA, which, as discussed above, provide guidelines to determine 
when compensation paid to a particular executive officer, employee, 
director or principal shareholder would be excessive. In enacting 
section 956, Congress referred specifically to the standards 
established under section 39 of the FDIA, and was presumably aware that 
in the statute there were no such standards articulated that provide 
guidance for determining whether compensation arrangements could lead 
to a material financial loss. The provisions of the proposed rule 
implementing section 956(b)(2) reflect the Agencies' intent to comply 
with the statutory mandate under section 956, while ensuring that the 
proposed rule is comparable to section 39 of the FDIA, which states 
that compensatory arrangements that could lead to a material financial 
loss are an unsafe and unsound practice.

[[Page 37710]]

    Section __.4(c) of the proposed rule sets forth minimum 
requirements for incentive-based compensation arrangements that would 
be permissible under the proposed rule, because arrangements without 
these attributes could encourage inappropriate risks that could lead to 
material financial loss to a covered institution. These requirements 
reflect the three principles for sound incentive-based compensation 
policies contained in the 2010 Federal Banking Agency Guidance: (1) 
Balanced risk-taking incentives; (2) compatibility with effective risk 
management and controls; and (3) effective corporate governance.\119\ 
Similarly, section __.4(c) of the proposed rule provides that an 
incentive-based compensation arrangement at a covered institution could 
encourage inappropriate risks that could lead to material financial 
loss to the covered institution, unless the arrangement: (1) 
Appropriately balances risk and reward; (2) is compatible with 
effective risk management and controls; and (3) is supported by 
effective governance.
---------------------------------------------------------------------------

    \119\ See 75 FR 36407-36413.
---------------------------------------------------------------------------

    An example of a feature that could encourage inappropriate risks 
that could lead to material financial loss would be the use of 
performance measures that are closely tied to short-term revenue or 
profit of business generated by a covered person, without any 
adjustments for the longer-term risks associated with the business 
generated. Similarly, if there is no mechanism for factoring risk 
outcomes over a longer period of time into compensation decisions, 
traders who have incentive-based compensation plans with performance 
periods that end at the end of the calendar year, could have an 
incentive to take large risks towards the end of the calendar year to 
either make up for underperformance earlier in the performance period 
or to maximize their year-end profits. The same result could ensue if 
the performance measures themselves are poorly designed or can be 
manipulated inappropriately by the covered persons receiving incentive-
based compensation.
    Incentive-based compensation arrangements typically attempt to 
encourage actions that result in greater revenue or profit for a 
covered institution. However, short-run revenue or profit can often 
diverge sharply from actual long-run profit because risk outcomes may 
become clear only over time. Activities that carry higher risk 
typically have the potential to yield higher short-term revenue, and a 
covered person who is given incentives to increase short-term revenue 
or profit, without regard to risk, would likely be attracted to 
opportunities to expose the covered institution to more risk that could 
lead to material financial loss.
    Section __.4(c)(1) of the proposed rule would require all covered 
institutions to ensure that incentive-based compensation arrangements 
appropriately balance risk and reward. Incentive-based compensation 
arrangements achieve balance between risk and financial reward when the 
amount of incentive-based compensation ultimately received by a covered 
person depends not only on the covered person's performance, but also 
on the risks taken in achieving this performance. Conversely, an 
incentive-based compensation arrangement that provides financial reward 
to a covered person without regard to the amount and type of risk 
produced by the covered person's activities would not be considered to 
appropriately balance risk and reward under the proposed rule.\120\ 
Incentive-based compensation arrangements should balance risk and 
financial rewards in a manner that does not encourage covered persons 
to expose a covered institution to inappropriate risk that could lead 
to material financial loss.
---------------------------------------------------------------------------

    \120\ For example, a covered person who makes a high-risk loan 
may generate more revenue in the short run than one who makes a low-
risk loan. Incentive-based compensation arrangements that reward 
covered persons solely on the basis of short-term revenue might pay 
more to the covered person taking more risk, thereby incentivizing 
employees to take more, and sometimes inappropriate, risk. See 2011 
FRB Report at 11.
---------------------------------------------------------------------------

    The incentives provided by an arrangement depend on how all 
features of the arrangement work together. For instance, how 
performance measures are combined, whether they take into account both 
current and future risks, which criteria govern the use of risk 
adjustment before the awarding and vesting of incentive-based 
compensation, and what form incentive-based compensation takes (i.e., 
equity-based vehicles or cash-based vehicles) can all affect risk-
taking incentives and generally should be considered when covered 
institutions create such arrangements.
    The 2010 Federal Banking Agency Guidance outlined four methods that 
can be used to make compensation more sensitive to risk--risk 
adjustments of awards, deferral of payment, longer performance periods, 
and reduced sensitivity to short-term performance.\121\ Consistent with 
the 2010 Federal Banking Agency Guidance, under the proposed rule, an 
incentive-based compensation arrangement generally would have to take 
account of the full range of current and potential risks that a covered 
person's activities could pose for a covered institution. Relevant 
risks would vary based on the type of covered institution, but could 
include credit, market (including interest rate and price), liquidity, 
operational, legal, strategic, and compliance risks. Performance and 
risk measures generally should align with the broader risk management 
objectives of the covered institution and could be incorporated through 
use of a formula or through the exercise of judgment. Performance and 
risk measures also may play a role in setting amounts of incentive-
based compensation pools (bonus pools), in allocating pools to 
individuals' incentive-based compensation, or both. The effectiveness 
of different types of adjustments varies with the situation of the 
covered person and the covered institution, as well as the thoroughness 
with which the measures are implemented.
---------------------------------------------------------------------------

    \121\ See 2010 Federal Banking Agency Guidance, 75 FR at 36396.
---------------------------------------------------------------------------

    The analysis and methods for ensuring that incentive-based 
compensation arrangements appropriately balance risk and reward should 
also be tailored to the size, complexity, business strategy, and risk 
tolerance of each institution. The manner in which a covered 
institution seeks to balance risk and reward in incentive-based 
compensation arrangements should account for the differences between 
covered persons--including the differences between senior executive 
officers and significant risk-takers and other covered persons. 
Activities and risks may vary significantly both among covered 
institutions and among covered persons within a particular covered 
institution. For example, activities, risks, and incentive-based 
compensation practices may differ materially among covered institutions 
based on, among other things, the scope or complexity of activities 
conducted and the business strategies pursued by the institutions. 
These differences mean that methods for achieving incentive-based 
compensation arrangements that appropriately balance risk and reward at 
one institution may not be effective in restraining incentives to 
engage in imprudent risk-taking at another institution.
    The proposed rule would require that incentive-based compensation 
arrangements contain certain features. Section __.4(d) sets out 
specific requirements that would be applicable to arrangements for all 
covered persons at all covered institutions and that are intended to 
result in incentive-based compensation arrangements that

[[Page 37711]]

appropriately balance risk and reward. Sections __.7 and __.8 of the 
proposed rule provide more specific requirements that would be 
applicable to arrangements at Level 1 and Level 2 covered institutions.
    While the proposed rule would require incentive-based compensation 
arrangements for senior executive officers and significant risk-takers 
at Level 1 and Level 2 covered institutions to have certain features 
(such as a certain percentage of the award deferred), those features 
alone would not be sufficient to balance risk-taking incentives with 
reward. The extent to which additional balancing methods are required 
would vary with the size and complexity of a covered institution and 
with the nature of a covered person's activities.
    Section __.4(c)(2) of the proposed rule provides that an incentive-
based compensation arrangement at a covered institution would encourage 
inappropriate risks that could lead to material financial loss to the 
covered institution unless the arrangement is compatible with effective 
risk management and controls. A covered institution's risk management 
processes and internal controls would have to reinforce and support the 
development and maintenance of incentive-based compensation 
arrangements that appropriately balance risk and reward required under 
section __.4(c)(1) of the proposed rule.
    One of the reasons risk management is important is that covered 
persons may seek to evade the processes established by a covered 
institution to achieve incentive-based compensation arrangements that 
appropriately balance risk and reward in an effort to increase their 
own incentive-based compensation. For example, a covered person might 
seek to influence the risk measures or other information or judgments 
that are used to make the covered person's incentive-based compensation 
sensitive to risk. Such actions may significantly weaken the 
effectiveness of a covered institution's incentive-based compensation 
arrangements in restricting inappropriate risk-taking and could have a 
particularly damaging effect if they result in the manipulation of 
measures of risk, information, or judgments that the covered 
institution uses for other risk-management, internal control, or 
financial purposes. In such cases, the covered person's actions may 
weaken not only the balance of the covered institution's incentive-
based compensation arrangements but also the risk-management, internal 
controls, and other functions that are supposed to act as a separate 
check on risk-taking.
    All covered institutions would have to have appropriate controls 
surrounding the design, implementation, and monitoring of incentive-
based compensation arrangements to ensure that processes for achieving 
incentive-based compensation arrangements that appropriately balance 
risk and reward are followed, and to maintain the integrity of their 
risk-management and other control functions. The nature of controls 
likely would vary by size and complexity of the covered institution as 
well as the activities of the covered person. For example, under the 
proposed rule, controls surrounding incentive-based compensation 
arrangements at smaller covered institutions likely would be less 
extensive and less formalized than at larger covered institutions. 
Level 1 and Level 2 covered institutions would be more likely to have a 
systematic approach to designing and implementing their incentive-based 
compensation arrangements, and their incentive-based compensation 
programs would more likely be supported by formalized and well-
developed policies, procedures, and systems. Level 3 covered 
institutions, on the other hand, might maintain less extensive and 
detailed incentive-based compensation programs. Section __.9 of the 
proposed rule provides additional, specific requirements that would be 
applicable to Level 1 and Level 2 covered institutions designed to 
result in incentive-based compensation arrangements at Level 1 and 
Level 2 covered institutions that are compatible with effective risk 
management and controls.
    Incentive-based compensation arrangements also would have to be 
supported by an effective governance framework. Section __.4(e) sets 
forth more detail on requirements for boards of directors of all 
covered institutions that would be designed to result in incentive-
based compensation arrangements that are supported by effective 
governance, while section __.10 of the proposed rule provides more 
specific requirements that would be applicable to Level 1 and Level 2 
covered institutions.
    The proposed requirement for effective governance is an important 
foundation of incentive-based compensation arrangements that 
appropriately balance risk and reward. The involvement of the board of 
directors in oversight of the covered institution's overall incentive-
based compensation program should be scaled appropriately to the scope 
of the covered institution's incentive-based compensation arrangements 
and the number of covered persons who have incentive-based compensation 
arrangements.
(d) Performance Measures
    The performance measures used in an incentive-based compensation 
arrangement have an important effect on the incentives provided to 
covered persons and thus affect the potential for the incentive-based 
compensation arrangement to encourage inappropriate risk-taking that 
could lead to material financial loss. Under section __.4(d) of the 
proposed rule, an incentive-based compensation arrangement would not be 
considered to appropriately balance risk and reward unless: (1) It 
includes financial and non-financial measures of performance that are 
relevant to a covered person's role and to the type of business in 
which the covered person is engaged and that are appropriately weighted 
to reflect risk-taking; (2) it is designed to allow non-financial 
measures of performance to override financial measures when 
appropriate; and (3) any amounts to be awarded under the arrangement 
are subject to adjustment to reflect actual losses, inappropriate risks 
taken, compliance deficiencies, or other measures or aspects of 
financial and non-financial performance. Each of these requirements is 
described more fully below.
    First, the arrangements would be required to include both financial 
and non-financial measures of performance. Financial measures of 
performance generally are measures tied to the attainment of strategic 
financial objectives of the covered institution, or one of its 
operating units, or to the contributions by covered persons towards 
attainment of such objectives, such as measures related to corporate 
sales, profit, or revenue targets. Non-financial measures of 
performance, on the other hand, could be assessments of a covered 
person's risk-taking or compliance with limits on risk-taking. These 
may include assessments of compliance with the covered institution's 
policies and procedures, adherence to the covered institution's risk 
framework and conduct standards, or compliance with applicable laws. 
These financial and non-financial measures of performance should 
include considerations of risk-taking, and be relevant to a covered 
person's role within the covered institution and to the type of 
business in which the covered person is engaged. They also should be 
appropriately weighted to

[[Page 37712]]

reflect the nature of such risk-taking. The requirement to include both 
financial and non-financial measures of performance would apply to 
forms of incentive-based compensation that set out performance measure 
goals and related amounts near the beginning of a performance period 
(such as long-term incentive plans) and to forms that do not 
necessarily specify performance measure goals and related amounts in 
advance of performance (such as certain bonuses). For example, a senior 
executive officer may have his or her performance evaluated based upon 
quantitative financial measures, such as return on equity, and on 
qualitative, non-financial measures, such as the extent to which the 
senior executive officer promoted sound risk management practices or 
provided strategic leadership through a difficult merger. The senior 
executive officer's performance also may be evaluated on several 
qualitative non-financial measures that in some instances span multiple 
calendar and performance years.
    Incentive-based compensation should support prudent risk-taking, 
but should also allow covered institutions to hold covered persons 
accountable for inappropriate behavior. Reliable quantitative measures 
of risk and risk outcomes, where available, may be particularly useful 
in both developing incentive-based compensation arrangements that 
appropriately balance risk and reward and assessing the extent to which 
incentive-based compensation arrangements properly balance risk and 
reward. However, reliable quantitative measures may not be available 
for all types of risk or for all activities, and in many cases may not 
be sufficient to fully assess the risks that the activities of covered 
persons may pose to covered institutions. Poor performance, as assessed 
by non-financial measures such as quality of risk management, could 
pose significant risks for the covered institution and may itself be a 
source of potential material financial loss at a covered institution. 
For this reason, non-financial performance measures play an important 
role in reinforcing expectations on appropriate risk, control, and 
compliance standards and should form a significant part of the 
performance assessment process.
    Under certain circumstances, it may be appropriate for non-
financial performance measures, which are the primary measures that 
relate to risk-taking behavior, to override considerations of financial 
performance measures. An override might be appropriate when, for 
example, a covered person conducts trades or other transactions that 
increase the covered institution's profit but that create an 
inappropriate compliance risk for the covered institution. In such a 
case, an incentive-based compensation arrangement should allow for the 
possibility that the non-financial measure of compliance risk could 
override the financial measure of profit when the amount of incentive-
based compensation to be awarded to the covered person is determined.
    The effective balance of risks and rewards may involve the use of 
both formulaic arrangements and discretion. At most covered 
institutions, management retains a significant amount of discretion 
when awarding incentive-based compensation. Although the use of 
discretion has the ability to reinforce risk balancing, when improperly 
utilized, discretionary decisions can undermine the goal of incentive-
based compensation arrangements to appropriately balance risk and 
reward. For example, an incentive-based compensation arrangement that 
has a longer performance period that could allow risk events to 
manifest and for awards to be adjusted to reflect risk could be less 
effective if management makes a discretionary award decision that does 
not account for, or mitigates, the future impact of those risk 
events.\122\
---------------------------------------------------------------------------

    \122\ For Level 1 and Level 2 covered institutions, section 
__.11 of the proposed rule would require policies and procedures 
that address the institution's use of discretion.
---------------------------------------------------------------------------

    Section __.4(d)(3) of the proposed rule would also require that any 
amounts to be awarded under an incentive-based compensation arrangement 
be subject to adjustment to reflect actual losses, inappropriate risks 
taken, compliance deficiencies, or other measures or aspects of 
financial and non-financial performance. It is important that 
incentive-based compensation arrangements be balanced in design and 
implemented so that awards and actual amounts that vest actually vary 
based on risks or risk outcomes. If, for example, covered persons are 
awarded or paid substantially all of their potential incentive-based 
compensation even when they cause a covered institution to take a risk 
that is inappropriate given the institution's size, nature of 
operations, or risk profile, or cause the covered institution to fail 
to comply with legal or regulatory obligations, then covered persons 
will have less incentive to avoid activities with substantial risk of 
financial loss or non-compliance with legal or regulatory obligations.
(e) Board of Directors
    Under section __.4(e) of the proposed rule, the board of directors, 
or a committee thereof, would be required to: (1) Conduct oversight of 
the covered institution's incentive-based compensation program; (2) 
approve incentive-based compensation arrangements for senior executive 
officers, including the amounts of all awards and, at the time of 
vesting, payouts under such arrangements; and (3) approve any material 
exceptions or adjustments to incentive-based compensation policies or 
arrangements for senior executive officers.
    Section __.4(e)(1) of the proposed rule would require the board of 
directors, or a committee thereof, of a covered institution to conduct 
oversight of the covered institution's incentive-based compensation 
program. Such oversight generally should include overall goals and 
purposes. For example, boards of directors, or a committee thereof, of 
covered institutions generally should oversee senior management in the 
development of an incentive-based compensation program that 
incentivizes behaviors consistent with the long-term health of the 
covered institution, and provide sufficient detail to enable senior 
management to translate the incentive-based compensation program into 
objectives, plans, and arrangements for each line of business and 
control function. Such oversight also generally should include holding 
senior management accountable for effectively executing the covered 
institution's incentive-based compensation program and for 
communicating expectations regarding acceptable behaviors and business 
practices to covered persons. Boards of directors should actively 
engage with senior management, including challenging senior 
management's incentive-based compensation assessments and 
recommendations when warranted.
    In addition to the general program oversight requirement set forth 
in section __.4(e)(1) of the proposed rule, a board of directors, or a 
committee thereof, would also be required by sections __.4(e)(2) and 
__.4(e)(3) to approve incentive-based compensation arrangements for 
senior executive officers, including the amounts of all awards and 
payouts, at the time of vesting, under such arrangements, and to 
approve any material exceptions or adjustments to those arrangements.
    Although risk-adjusting incentive-based compensation for senior 
executive officers responsible for the covered institution's overall 
risk posture and

[[Page 37713]]

performance may be challenging given that quantitative measures of 
institution-wide risk are difficult to produce and allocating 
responsibility among the senior executive team for achieving risk 
objectives can be a complex task, the role of senior executive officers 
in managing the overall risk-taking activities of an institution is 
important. Accordingly the proposed rule would require the board of 
directors, or a committee thereof, to approve compensation arrangements 
involving senior executive officers. When a board of directors, or a 
committee thereof, is considering an award or a payout, it should 
consider risks to ensure that the award or payout is consistent with 
broader risk management and strategic objectives.
(f) Disclosure and Recordkeeping Requirements and (g) Rule of 
Construction
    Section __.4(f) of the proposed rule would establish disclosure and 
recordkeeping requirements for all covered institutions, as required by 
section 956(a)(1).\123\ Under the proposed rule, each covered 
institution would be required to create and maintain records that 
document the structure of all of the institution's incentive-based 
compensation arrangements and demonstrate compliance with the proposed 
rule, and to disclose these records to the appropriate Federal 
regulator upon request. The proposed rule would require covered 
institutions to create such records on an annual basis and to maintain 
such records for at least seven years after they are created. The 
Agencies recognize that the exact timing for recordkeeping will vary 
from institution to institution, but this requirement would ensure that 
covered institutions create such records for their incentive-based 
compensation arrangements at least once every 12 months. The 
requirement to maintain records for at least seven years generally 
aligns with the clawback period described in section __.7(c) of the 
proposed rule.
---------------------------------------------------------------------------

    \123\ 12 U.S.C. 5641(a)(1).
---------------------------------------------------------------------------

    The proposed rule would require that the records maintained by a 
covered institution, at a minimum, include copies of all incentive-
based compensation plans, a list of who is subject to each plan, and a 
description of how the covered institution's incentive-based 
compensation program is compatible with effective risk management and 
controls. These records would be the minimum required information to 
determine whether the structure of the covered institution's incentive-
based compensation arrangements provide covered persons with excessive 
compensation or could lead to material financial loss to the covered 
institution. As specified in section 956(a)(2) and section __.4(g) of 
the proposed rule, a covered institution would not be required to 
report the actual amount of compensation, fees, or benefits of 
individual covered persons as part of this requirement.\124\
---------------------------------------------------------------------------

    \124\ The Agencies note that covered institutions may be 
required to report actual compensation under other provisions of 
law. For example, corporate credit unions must disclose compensation 
of certain executive officers to their natural person credit union 
members under NCUA's corporate credit union rule. 12 CFR 704.19. The 
proposed rule would not affect the requirements in 12 CFR 704.19 or 
in any other reporting provision under any other law or regulation.
    The SEC requires an issuer that is subject to the requirements 
of section 13(a) or 15(d) of the Securities Exchange Act of 1934 (15 
U.S.C. 78m or 78o(d)) to disclose information regarding the 
compensation of its principal executive officer, principal financial 
officer, and three other most highly compensated executive officers, 
as well as its directors, in the issuer's proxy statement, its 
annual report on Form 10-K, and registration statements for 
offerings of securities. The requirements are generally found in 
Item 402 of Regulation S-K (17 CFR 229.402).
---------------------------------------------------------------------------

    The 2011 Proposed Rule would have implemented section 956(a)(1) by 
requiring all covered financial institutions to submit an annual report 
to their appropriate Federal regulator, in a format specified by their 
appropriate Federal regulator, that described in narrative form the 
structure of the covered financial institution's incentive-based 
compensation arrangements for covered persons and the policies 
governing such arrangements.\125\ Some commenters on the 2011 Proposed 
Rule favored annual reporting requirements, while other commenters 
opposed any requirement for institutions to make periodic submissions 
of information about incentive-based compensation arrangements to 
regulators, noting concerns about burden, particularly for smaller 
covered financial institutions. A few commenters requested an annual 
certification requirement instead of a reporting requirement. While 
there is value in receiving reports, the burden of producing them would 
potentially be great on smaller covered institutions. Accordingly, the 
Agencies determined not to include a requirement for covered 
institutions to submit annual narrative reports.
---------------------------------------------------------------------------

    \125\ See 2011 Proposed Rule, at 21177. The 2011 Proposed Rule 
also would have set forth additional more detailed requirements for 
covered financial institutions with total consolidated assets of $50 
billion or more.
---------------------------------------------------------------------------

    Given the variety of covered institutions and asset sizes, the 
Agencies are not proposing a specific format or template for the 
records that must be maintained by all covered institutions. According 
to the Agencies' supervisory experience, as discussed further above, 
many covered institutions already maintain information about their 
incentive-based compensation programs comparable to the types of 
information described above (e.g., in support of public company 
filings).
    Several commenters on the 2011 Proposed Rule expressed concern 
regarding the confidentiality of the reported compensation information. 
In light of the nature of the information that would be provided to the 
Agencies under section __.4(f) of the proposed rule, and the purposes 
for which the Agencies are requiring the information, the Agencies 
would view the information disclosed to the Agencies as nonpublic and 
expect to maintain the confidentiality of that information, to the 
extent permitted by law.\126\ When providing information to one of the 
Agencies pursuant to the proposed rule, covered institutions should 
request confidential treatment by that Agency.
---------------------------------------------------------------------------

    \126\ For example, Exemption 4 of the Freedom of Information Act 
(``FOIA'') provides an exemption for ``trade secrets and commercial 
or financial information obtained from a person and privileged or 
confidential.'' 5 U.S.C. 552(b)(4). FOIA Exemption 6 provides an 
exemption for information about individuals in ``personnel and 
medical files and similar files'' when the disclosure of such 
information ``would constitute a clearly unwarranted invasion of 
personal privacy.'' 5 U.S.C. 552(b)(6). FOIA Exemption 8 provides an 
exemption for matters that are ``contained in or related to 
examination, operating, or condition reports prepared by, on behalf 
of, or for the use of an agency responsible for the regulation or 
supervision of financial institutions.'' 5 U.S.C. 552(b)(8).
---------------------------------------------------------------------------

    4.1. The Agencies invite comment on the requirements for 
performance measures contained in section __.4(d) of the proposed rule. 
Are these measures sufficiently tailored to allow for incentive-based 
compensation arrangements to appropriately balance risk and reward? If 
not, why?
    4.2. The Agencies invite comment on whether the terms ``financial 
measures of performance'' and ``non-financial measures of performance'' 
should be defined. If so, what should be included in the defined terms?
    4.3. Would preparation of annual records be appropriate or should 
another method be used? Would covered institutions find a more specific 
list of topics and quantitative information for the content of required 
records helpful? Should covered institutions be required to maintain an 
inventory of all such records and to maintain such records in a 
particular format? If so, why? How would such specific requirements 
increase or decrease burden?

[[Page 37714]]

    4.4. Should covered institutions only be required to create new 
records when incentive-based compensation arrangements or policies 
change? Should the records be updated more frequently, such as promptly 
upon a material change? What should be considered a ``material 
change''?
    4.5. Is seven years a sufficient time to maintain the records 
required under section __.4(f) of the proposed rule? Why or why not?
    4.6. Do covered institutions generally maintain records on 
incentive-based compensation arrangements and programs? If so, what 
types of records and related information are maintained and in what 
format? What are the legal or institutional policy requirements for 
maintaining such records?
    4.7. For covered institutions that are investment advisers or 
broker-dealers, is there particular information that would assist the 
SEC in administering the proposed rule? For example, should the SEC 
require its reporting entities to report whether they utilize 
incentive-based compensation or whether they are Level 1, Level 2 or 
Level 3 covered institutions?

Sec.  __.5 Additional Disclosure and Recordkeeping Requirements for 
Level 1 and Level 2 Covered Institutions

    Section __.5 of the proposed rule would establish additional and 
more detailed recordkeeping requirements for Level 1 and Level 2 
covered institutions.
    Under section __.5(a) of the proposed rule, a Level 1 or Level 2 
covered institution would be required to create annually, and maintain 
for at least seven years, records that document: (1) Its senior 
executive officers and significant risk-takers listed by legal entity, 
job function, organizational hierarchy, and line of business; (2) the 
incentive-based compensation arrangements for senior executive officers 
and significant risk-takers, including information on percentage of 
incentive-based compensation deferred and form of award; (3) any 
forfeiture and downward adjustment or clawback reviews and decisions 
for senior executive officers and significant risk-takers; and (4) any 
material changes to the covered institution's incentive-based 
compensation arrangements and policies.
    The proposed recordkeeping and disclosure requirements at Level 1 
and Level 2 covered institutions would assist the appropriate Federal 
regulator in monitoring whether incentive-based compensation 
structures, and any changes to such structures, could result in Level 1 
and Level 2 covered institutions maintaining incentive-based 
compensation structures that encourage inappropriate risks by providing 
excessive compensation, fees, or benefits or could lead to material 
financial loss. The more detailed reporting requirement for Level 1 and 
Level 2 covered institutions under section __.5(a) of the proposed rule 
reflects the information that would assist the appropriate Federal 
regulator in most effectively evaluating the covered institution's 
compliance with the proposed rule and identifying areas of potential 
concern with respect to the structure of the covered institution's 
incentive-based compensation arrangements.
    For example, the recordkeeping requirement in section __.5(a)(2) of 
the proposed rule regarding amounts of incentive-based compensation 
deferred and the form of payment of incentive-based compensation for 
senior executive officers and significant risk-takers would help 
Federal regulators determine compliance with the requirement in section 
__.7(a) of the proposed rule for certain amounts of incentive-based 
compensation of senior executive officers and significant risk-takers 
to be deferred for specific periods of time. Similarly, the 
recordkeeping requirement in section __.5(a)(3) of the proposed rule 
would require Level 1 and Level 2 covered institutions to document the 
rationale for decisions under forfeiture and downward adjustment 
reviews and to keep timely and accurate records of the decision. This 
documentation would provide information useful to Federal regulators 
for determining compliance with the requirements in sections__.7(b) and 
(c) of the proposed rule regarding specific forfeiture and clawback 
policies at Level 1 and Level 2 covered institutions that are further 
discussed below.
    The proposed recordkeeping requirements in section __.5(a) of the 
proposed rule relate to the proposed substantive requirements in 
section __.7 of the proposed rule and would help the appropriate 
Federal regulator to closely monitor incentive-based compensation 
payments to senior executive officers and significant risk-takers and 
to determine whether those payments have been adjusted to reflect risk 
outcomes. This approach also would be responsive to comments received 
on the 2011 Proposed Rule suggesting that specific qualitative and 
quantitative information, instead of a narrative description, be the 
basis of a reporting requirement for larger covered institutions.
    Section __.5(b) of the proposed rule would require a Level 1 or 
Level 2 covered institution to create and maintain records sufficient 
to allow for an independent audit of incentive-based compensation 
arrangements, policies, and procedures, including those required under 
section __.11 of the proposed rule. A standard which reflects the level 
of detail required in order to perform an independent audit of 
incentive-based compensation would be appropriate given the importance 
of regular monitoring of incentive-based compensation programs by 
independent control functions. Such a standard also would be consistent 
with the monitoring requirements set out in section __.11 of the 
proposed rule.
    As with the requirements applicable to all covered institutions 
under section __.4(f) of the proposed rule, the Agencies are not 
proposing to require that a Level 1 or Level 2 covered institution 
annually file a report with the appropriate Federal regulator. Instead, 
section __.5(c) of the proposed rule would require a Level 1 or Level 2 
covered institution to disclose its records to the appropriate Federal 
regulator in such form and with such frequency as requested by the 
appropriate Federal regulator. The required form and frequency of 
recordkeeping may vary among the Agencies and across categories of 
covered institutions, although the records described in section __.5(a) 
of the proposed rule, along with any other records a covered 
institution creates to satisfy the requirements of section __.5(f) of 
the proposed rule, would be required to be created at least annually. 
Some Agencies may require Level 1 and Level 2 covered institutions to 
provide their records on an annual basis, alone or with a standardized 
form of report. Level 1 and Level 2 covered institutions should seek 
guidance concerning the reporting requirement from their appropriate 
Federal regulator.
    Generally, the Agencies would expect the volume and detail of 
information disclosed by a covered institution under section __.5 of 
the proposed rule to be tailored to the nature and complexity of 
business activities at the covered institution, and to the scope and 
nature of its use of incentive-based compensation arrangements. The 
Agencies recognize that smaller covered institutions with less complex 
and less extensive incentive-based compensation arrangements likely 
would not create or retain records that are as extensive as those that 
larger covered institutions with relatively complex programs and 
business activities would likely create. The tailored recordkeeping and

[[Page 37715]]

disclosure provisions for Level 1 and Level 2 covered institutions in 
the proposed rule are designed to provide the Agencies with streamlined 
and well-focused records that would allow the Agencies to promptly and 
effectively identify and address any areas of concern.
    Similar to the provision of information under section __.4(f) of 
the proposed rule, the Agencies expect to treat the information 
provided to the Agencies under section __.5 of the proposed rule as 
nonpublic and to maintain the confidentiality of that information to 
the extent permitted by law.\127\ When providing information to one of 
the Agencies pursuant to the proposed rule, covered institutions should 
request confidential treatment by that Agency.
---------------------------------------------------------------------------

    \127\ See supra note 126.
---------------------------------------------------------------------------

    5.1. Should the level of detail in records created and maintained 
by Level 1 and Level 2 covered institutions vary among institutions 
regulated by different Agencies? If so, how? Or would it be helpful to 
use a template with a standardized information list?
    5.2. In addition to the proposed records, what types of information 
should Level 1 and Level 2 covered institutions be required to create 
and maintain related to deferral and to forfeiture, downward 
adjustment, and clawback reviews?

Sec.  __.6 Reservation of Authority for Level 3 Covered Institutions

    Section __.6 of the proposed rule would allow the appropriate 
Federal regulator to require certain Level 3 covered institutions to 
comply with some or all of the more rigorous requirements applicable to 
Level 1 and Level 2 covered institutions. Specifically, an Agency would 
be able to require a covered institution with average total 
consolidated assets greater than or equal to $10 billion and less than 
$50 billion to comply with some or all of the more rigorous provisions 
of section __.5 and sections __.7 through __.11 of the proposed rule, 
if the appropriate Federal regulator determined that the covered 
institution's complexity of operations or compensation practices are 
consistent with those of a Level 1 or Level 2 covered institution, 
based on the covered institution's activities, complexity of 
operations, risk profile, or compensation practices. In such cases, the 
Agency that is the Level 3 covered institution's appropriate Federal 
regulator, in accordance with procedures established by the Agency, 
would notify the institution in writing that it must satisfy the 
requirements and other standards contained in section __.5 and sections 
__.7 through __.11 of the proposed rule. As with the designation of 
significant risk-takers discussed above, each Agency's procedures 
generally would include reasonable advance written notice of the 
proposed action, including a description of the basis for the proposed 
action, and opportunity for the covered institution to respond.
    As noted previously, the Agencies have determined that it may be 
appropriate to apply only basic prohibitions and disclosure 
requirements to Level 3 covered institutions, in part because these 
institutions generally have less complex operations, incentive-based 
compensation practices, and risk profiles than Level 1 and Level 2 
covered institutions.\128\ However, the Agencies recognize that there 
is a wide spectrum of business models and risk profiles within the $10 
to $50 billion range and believe that some Level 3 covered institutions 
with between $10 and $50 billion in total consolidated assets may have 
incentive-based compensation practices and operational complexity 
comparable to those of a Level 1 or Level 2 covered institution. In 
such cases, it may be appropriate for the Agencies to provide a process 
for determining that such institutions should be held to the more 
rigorous standards.
---------------------------------------------------------------------------

    \128\ See section 3 of Part II of this Supplementary Information 
for more discussions on Level 1, Level 2, and Level 3 covered 
institutions.
---------------------------------------------------------------------------

    The Agencies are proposing $10 billion as the appropriate threshold 
for the low end of this range based upon the general complexity of 
covered institutions above this size. The threshold is also used in 
other statutory and regulatory requirements. For example, the stress 
testing provisions of the Dodd-Frank Act require banking organizations 
with total consolidated assets of more than $10 billion to conduct 
annual stress tests.\129\ For deposit insurance assessment purposes, 
the FDIC distinguishes between small and large banks based on a $10 
billion asset size.\130\ For supervisory purposes, the Board defines 
community banks by reference to the $10 billion asset size 
threshold.\131\
---------------------------------------------------------------------------

    \129\ 12 U.S.C. 5365(i)(2).
    \130\ See 12 CFR 327.8(e) and (f).
    \131\ See Federal Reserve SR Letter 12-7, ``Supervisory Guidance 
on Stress Testing for Banking Organizations with More Than $10 
Billion in Total Consolidated Assets'' (May 14, 2012).
---------------------------------------------------------------------------

    The Agencies would consider the activities, complexity of 
operations, risk profile, and compensation practices to determine 
whether a Level 3 covered institution's operations or compensation 
practices warrant application of additional standards pursuant to the 
proposed rule. For example, a Level 3 covered institution could have 
significant levels of off-balance sheet activities, such as derivatives 
that may entail complexities of operations and greater risk than 
balance sheet measures would indicate, making the institution's risk 
profile more akin to that of a Level 1 or Level 2 covered institution. 
Additionally, a Level 3 covered institution might be involved in 
particular high-risk business lines, such as lending to distressed 
borrowers or investing or trading in illiquid assets, and make 
significant use of incentive-based compensation to reward risk-takers. 
Still other Level 3 covered institutions might have or be part of a 
complex organizational structure, such as operating with multiple legal 
entities in multiple foreign jurisdictions.
    Section __.6 of the proposed rule would permit the appropriate 
Federal regulator of a Level 3 covered institution with total 
consolidated assets of between $10 and $50 billion to require the 
institution to comply with some or all of the provisions of section 
__.5 and sections __.7 through __.11 of the proposed rule. This 
approach would allow the Agencies to take a flexible approach in the 
proposed rule provisions applicable to all Level 3 covered institutions 
while retaining authority to apply more rigorous standards where the 
Agencies determine appropriate based on the Level 3 covered 
institution's complexity of operations or compensation practices. The 
Agencies expect they only would use this authority on an infrequent 
basis. This approach has been used in other rules for purposes of 
tailoring the application of requirements and providing flexibility to 
accommodate the variations in size, complexity, and overall risk 
profile of financial institutions.\132\
---------------------------------------------------------------------------

    \132\ For example, the OCC, FDIC, and Board's domestic capital 
rules include a reservation of authority whereby the agency may 
require an institution to hold an amount of regulatory capital 
greater than otherwise required under the capital rules. 12 CFR 
3.1(d) (OCC); 12 CFR 324.1(d)(1) through (6) (FDIC); 12 CFR 217.1(d) 
(Board). The OCC, FDIC, and the Board's Liquidity Coverage Ratio 
rule includes a reservation of authority whereby each agency may 
impose heightened standards on an institution. 12 CFR 50.2 (OCC); 12 
CFR 329.2 (FDIC); 12 CFR 249.2 (Board). The FDIC's stress testing 
rules include a reservation of authority to require a $10 billion to 
$50 billion covered bank to use reporting templates for larger 
banks. 12 CFR 325.201.
---------------------------------------------------------------------------

    6.1. The Agencies invite general comment on the reservation of 
authority in section __.6 of the proposed rule.

[[Page 37716]]

    6.2. The Agencies based the $10 billion dollar floor of the 
reservation of authority on existing similar reservations of authority 
that have been drawn at that level. Did the Agencies set the correct 
threshold or should the floor be set lower or higher than $10 billion? 
If so, at what level and why?
    6.3. Are there certain provisions in section __.5 and sections __.7 
through __.11 of the proposed rule that would not be appropriate to 
apply to a covered institution with total consolidated assets of $10 
billion or more and less than $50 billion regardless of its complexity 
of operations or compensation practices? If so, which provisions and 
why?
    6.4. The Agencies invite comment on the types of notice and 
response procedures the Agencies should use in determining that the 
reservation of authority should be used. The SEC invites comment on 
whether notice and response procedures based on the procedures for a 
proceeding initiated upon the SEC's own motion under Advisers Act rule 
0-5 would be appropriate for this purpose.
    6.5. What specific features of incentive-based compensation 
programs or arrangements at a Level 3 covered institution should the 
Agencies consider in determining such institution should comply with 
some or all of the more rigorous requirements within the rule and why? 
What process should be followed in removing such institution from the 
more rigorous requirements?

Sec.  __.7 Deferral, Forfeiture and Downward Adjustment, and Clawback 
Requirements for Level 1 and Level 2 Covered Institutions

    As discussed above, allowing covered institutions time to measure 
results with the benefit of hindsight allows for a more accurate 
assessment of the consequences of risks to which the institution has 
been exposed. This approach may be particularly relevant, for example, 
where performance is difficult to measure because performance results 
and risks take time to observe (e.g., assessing the future repayment 
prospects of loans written during the current year).
    In order to achieve incentive-based compensation arrangements that 
appropriately balance risk and reward, including closer alignment 
between the interests of senior executive officers and significant 
risk-takers within the covered institution and the longer-term 
interests of the covered institution itself, it is important for 
information on performance, including information on misconduct and 
inappropriate risk-taking, to affect the incentive-based compensation 
amounts received by covered persons. Covered institutions may use 
deferral, forfeiture and downward adjustment, and clawback to address 
information about performance that comes to light after the conclusion 
of the performance period, so that incentive-based compensation 
arrangements are able to appropriately balance risk and reward. Section 
__.7 of the proposed rule would require Level 1 and Level 2 covered 
institutions to incorporate these tools into the incentive-based 
compensation arrangements of senior executive officers and significant 
risk-takers.
    Under the proposed rule, an incentive-based compensation 
arrangement at a Level 1 or Level 2 covered institution would not be 
considered to appropriately balance risk and reward, as would be 
required by section __.4(c)(1), unless the deferral, forfeiture, 
downward adjustment, and clawback requirements of section __.7 are met. 
These requirements would apply to incentive-based compensation 
arrangements provided to senior executive officers and significant 
risk-takers at Level 1 and Level 2 covered institutions. Institutions 
may, of course, take additional steps to address risks that may mature 
after the performance period.
    The requirements of section __.7 of the proposed rule would apply 
to Level 1 and Level 2 covered institutions; that is, to covered 
institutions with $50 billion or more in average total consolidated 
assets. The requirements of section __.7 would not be applicable to 
Level 3 covered institutions.\133\ As discussed above, the Agencies 
recognize that larger covered institutions have more complex business 
activities and generally rely more on incentive-based compensation 
programs, and, therefore, it is appropriate to impose specific 
deferral, forfeiture and downward adjustment reviews and clawback 
requirements on these institutions. It has been recognized that larger 
financial institutions can present greater potential systemic risks. 
The Board, for example, has expressed the view that institutions with 
more than $250 billion in total consolidated assets are more likely 
than other institutions to pose systemic risk to U.S. financial 
stability.\134\ Because of these risks that could be created by 
excessive risk-taking at the largest covered institutions, additional 
safeguards are needed against inappropriate risk-taking at Level 1 
covered institutions. For these reasons, the Agencies are proposing a 
required minimum deferral percentage and a required minimum deferral 
period for Level 1 covered institutions that are greater than those for 
Level 2 covered institutions.
---------------------------------------------------------------------------

    \133\ As explained earlier in this Supplementary Information 
section, the appropriate Federal regulator of a Level 3 covered 
institution with average total consolidated assets greater than or 
equal to $10 billion and less than $50 billion may require the 
covered institution to comply with some or all of the provisions of 
section __.5 and sections __.7 through __.11 of the proposed rule if 
the Agency determines that the complexity of operations or 
compensation practices of the Level 3 covered institution are 
consistent with those of a Level 1 or 2 covered institution.
    \134\ Board, Regulatory Capital Rules: Implementation of Risk-
Based Capital Surcharges for Global Systemically Important Bank 
Holding Companies, 80 FR 49082, 49084 (August 14, 2015).
---------------------------------------------------------------------------

    The requirements of section __.7 of the proposed rule would apply 
to incentive-based compensation arrangements for senior executive 
officers and significant risk-takers of Level 1 and Level 2 covered 
institutions. The decisions of senior executive officers can have a 
significant impact on the entire consolidated organization and often 
involve substantial strategic or other risks that can be difficult to 
measure and model--particularly at larger covered institutions--during 
or at the end of the performance period, and therefore can be difficult 
to address adequately by risk adjustments in the awarding of incentive-
based compensation.\135\ Supervisory experience and a review of the 
academic literature \136\ suggest that incentive-based compensation 
arrangements for the most senior decision-makers and risk-takers at the 
largest institutions appropriately balance risk and reward when a 
significant portion of the incentive-based compensation awarded under 
those arrangements is deferred for an adequate amount of time.
---------------------------------------------------------------------------

    \135\ This premise was identified in the 2010 Federal Banking 
Agency Guidance, 75 FR at 36409, and was highlighted in the 2011 FRB 
White Paper. The report reiterated the recommendation that ``[a] 
substantial fraction of incentive compensation awards should be 
deferred for senior executives of the firm because other methods of 
balancing risk taking incentives are less likely to be effective by 
themselves for such individuals.'' 2011 FRB White Paper, at 15.
    \136\ Gopalan, Milbourn, Song and Thakor, ``Duration of 
Executive Compensation'' (December 18, 2012), at 29-30, available at 
http://apps.olin.wustl.edu/faculty/thakor/Website%20Papers/Duration%20of%20Executive%20Compensation.pdf.
---------------------------------------------------------------------------

    As discussed above, in addition to the institution's senior 
executive officers, the significant risk-takers at Level 1 and Level 2 
covered institutions may have the ability to expose the institution to 
the risk of material financial loss. In order to help ensure that the 
incentive-based compensation arrangements for these individuals 
appropriately balance risk and reward and do not encourage

[[Page 37717]]

them to engage in inappropriate risk-taking that could lead to material 
financial loss, the proposed rule would extend the deferral requirement 
to significant risk-takers at Level 1 and Level 2 covered institutions. 
Deferral for significant risk-takers as well as executive officers 
helps protect against material financial loss at the largest covered 
institutions.

Sec.  __.7(a) Deferral

    As a tool to balance risk and reward, deferral generally consists 
of four components: the proportion of incentive-based compensation 
required to be deferred, the time horizon of the deferral, the speed at 
which deferred incentive-based compensation vests, and adjustment 
during the deferral period to reflect risks or inappropriate conduct 
that manifest over that period of time.
    Section __.7(a) of the proposed rule would require Level 1 and 
Level 2 covered institutions, at a minimum, to defer the vesting of a 
certain portion of all incentive-based compensation awarded (the 
deferral amount) to a senior executive officer or significant risk-
taker for at least a specified period of time (the deferral period). 
The minimum required deferral amount and minimum required deferral 
period would be determined by the size of the covered institution, by 
whether the covered person is a senior executive officer or significant 
risk-taker, and by whether the incentive-based compensation was awarded 
under a long-term incentive plan or is qualifying incentive-based 
compensation. Minimum required deferral amounts range from 40 percent 
to 60 percent of the total incentive-based compensation award, and 
minimum required deferral periods range from one year to four years, as 
detailed below.
    Deferred incentive-based compensation of senior executive officers 
and significant risk-takers at Level 1 and Level 2 covered institutions 
would also be required to meet the following other requirements:
     Vesting of deferred amounts may occur no faster than on a 
pro rata annual basis beginning on the one-year anniversary of the end 
of the performance period;
     Unvested deferred amounts may not be increased during the 
deferral period;
     For most Level 1 and Level 2 covered institutions, 
substantial portions of deferred incentive-based compensation must be 
paid in the form of both equity-like instruments and deferred cash;
     Vesting of unvested deferred amounts may not be 
accelerated except in the case of death or disability; \137\ and
---------------------------------------------------------------------------

    \137\ For covered persons at credit unions, NCUA's rule also 
permits acceleration of payment if the covered person must pay 
income taxes on the entire amount of an award, including deferred 
amounts, at the time of award.
---------------------------------------------------------------------------

     All unvested deferred amounts must be placed at risk of 
forfeiture and subject to a forfeiture and downward adjustment review 
pursuant to section __.7(b).
    Except for the prohibition against accelerated vesting, the 
prohibitions and requirements in section __.7(a) of the proposed rule 
would apply to all unvested deferred incentive-based compensation, 
regardless of whether the deferral of the incentive-based compensation 
was necessary to meet the requirements of the proposed rule. For 
example, if a covered institution chooses to defer incentive-based 
compensation above the amount required to be deferred under the rule, 
the additional amount would be required to be subject to forfeiture. In 
another example, if a covered institution would be required to defer a 
portion of a particular covered person's incentive-based compensation 
for four years, but chooses to defer that compensation for ten years, 
the deferral would be subject to forfeiture during the entire ten-year 
deferral period. Applying the requirements and prohibitions of section 
__.7(a) to all unvested deferred incentive-based compensation is 
intended to maximize the balancing effect of deferred incentive-based 
compensation, to make administration of the requirements and 
prohibitions easier for covered institutions, and to facilitate the 
Agencies' supervision for compliance.
    Compensation that is not incentive-based compensation and is 
deferred only for tax purposes would not be considered ``deferred 
incentive-based compensation'' for purposes of the proposed rule.

Sec.  __.7(a)(1) and Sec.  __.7(a)(2) Minimum Deferral Amounts and 
Deferral Periods for Qualifying Incentive-Based Compensation and 
Incentive-Based Compensation Awarded Under a Long-Term Incentive Plan

    The proposed rule would require a Level 1 covered institution to 
defer at least 60 percent of each senior executive officer's qualifying 
incentive-based compensation \138\ for at least four years, and at 
least 60 percent of each senior executive officer's incentive-based 
compensation awarded under a long-term incentive plan for at least two 
years beyond the end of that plan's performance period. A Level 1 
covered institution would be required to defer at least 50 percent of 
each significant risk-taker's qualifying incentive-based compensation 
for at least four years, and at least 50 percent of each significant 
risk-taker's incentive-based compensation awarded under a long-term 
incentive plan for at least two years beyond the end of that plan's 
performance period.
---------------------------------------------------------------------------

    \138\ As described above, incentive-based compensation that is 
not awarded under a long-term incentive plan would be defined as 
qualifying incentive-based compensation under the proposed rule.
---------------------------------------------------------------------------

    Similarly, the proposed rule would require a Level 2 covered 
institution to defer at least 50 percent of each senior executive 
officer's qualifying incentive-based compensation for at least three 
years, and at least 50 percent of each senior executive officer's 
incentive-based compensation awarded under a long-term incentive plan 
for at least one year beyond the end of that plan's performance period. 
A Level 2 covered institution would be required to defer at least 40 
percent of each significant risk-taker's qualifying incentive-based 
compensation for at least three years, and at least 40 percent of each 
significant risk-taker's incentive-based compensation awarded under a 
long-term incentive plan for at least one year beyond the end of that 
plan's performance period.
    In practice, a Level 1 or Level 2 covered institution typically 
evaluates the performance of a senior executive officer or significant 
risk-taker during and after the performance period. As the performance 
period comes to a close, the covered institution determines an amount 
of incentive-based compensation to award the covered person for that 
performance period. Senior executive officers and significant risk-
takers may be awarded incentive-based compensation at a given time 
under multiple incentive-based compensation plans that have performance 
periods that come to a close at that time. Although they end at the 
same time, those performance periods may have differing lengths, and 
therefore may not completely overlap. For example, long-term incentive 
plans, which have a minimum performance period of three years, would 
consider performance in at least two years prior to the year the 
performance period ends, while annual incentive plans would only 
consider performance in the year of the performance period.
    For purposes of determining the amount of incentive-based 
compensation that would be required to be deferred and the actual 
amount that

[[Page 37718]]

would be deferred, a Level 1 or Level 2 covered institution generally 
should use the present value of the incentive-based compensation at the 
time of the award. In determining the value of awards for this purpose, 
Level 1 and Level 2 covered institutions generally should use 
reasonable valuation methods consistent with methods used in other 
contexts.\139\
---------------------------------------------------------------------------

    \139\ See, e.g., Topic 718 of the FASB Accounting Standards 
Codification (formerly FAS 123(R); Black-Scholes method for valuing 
options.
---------------------------------------------------------------------------

Pro Rata Vesting
    The requirements of this section would permit the covered 
institution to immediately pay, or allow to vest, all of the incentive-
based compensation that is awarded that is not required to be deferred. 
All incentive-based compensation that is deferred would be subject to a 
deferral period that begins only once the performance period comes to a 
close. During this deferral period, indications of inappropriate risk-
taking may arise, leading the covered institution to consider whether 
the covered person should not be paid the entire amount originally 
awarded.
    The incentive-based compensation that would be required by the rule 
to be deferred would not be permitted to vest faster than on a pro rata 
annual basis beginning no earlier than the first anniversary of the end 
of the performance period for which the compensation was awarded. In 
other words, a covered institution would be allowed to make deferred 
incentive-based compensation eligible for vesting during the deferral 
period on a schedule that paid out equal amounts on each anniversary of 
the end of the relevant performance period. A covered institution would 
also be permitted to make different amounts eligible for vesting each 
year, so long as the cumulative total of the deferred incentive-based 
compensation that has been made eligible for vesting on each 
anniversary of the end of the performance period is not greater than 
the cumulative total that would have been eligible for vesting had the 
covered institution made equal amounts eligible for vesting each year.
    For example, if a Level 1 covered institution is required to defer 
$100,000 of a senior executive officer's incentive-based compensation 
for four years, the covered institution could choose to make $25,000 
available for vesting on each anniversary of the end of the performance 
period for which the $100,000 was awarded. The Level 1 covered 
institution could also choose to make different amounts available for 
vesting at different times during the deferral period, as long as: The 
total amount that is made eligible for vesting on the first anniversary 
is not more than $25,000; the total amount that has been made eligible 
for vesting by the second anniversary is not more than $50,000; and the 
total amount that has been made eligible for vesting by the third 
anniversary is not more than $75,000. In this example, the Level 1 
covered institution would be permitted to make eligible for vesting 
$10,000 on the first anniversary, $30,000 on the second anniversary 
(bringing the total for the first and second anniversaries to $40,000), 
$30,000 on the third anniversary (bringing the total for the first, 
second, and third anniversaries to $70,000), and $30,000 on the fourth 
anniversary.
    A Level 1 or Level 2 covered institution should consider the 
vesting schedule at the time of the award, and the present value at 
time of award of each form of incentive-based compensation, for the 
purposes of determining compliance with this requirement. Level 1 and 
Level 2 covered institutions generally should use reasonable valuation 
methods consistent with methods used in other contexts in valuing 
awards for purposes of this rule.
    This approach would provide a covered institution with some 
flexibility in administering its specific deferral program. For 
example, a covered institution would be permitted to make the full 
deferred amount of incentive-based compensation awarded for any given 
year eligible for vesting in a lump sum at the conclusion of the 
deferral period (i.e., ``cliff vesting''). Alternatively, a covered 
institution would be permitted to make deferred amounts eligible for 
vesting in equal increments at the end of each year of the deferral 
period. Except in the case of acceleration allowed in sections 
__.7(a)(1)(iii)(B) and __.7(a)(2)(iii)(B), the proposed rule does not 
allow for vesting of amounts required to be deferred (1) faster than on 
a pro rata annual basis; or (2) beginning earlier than the first 
anniversary of the award date.
    The Agencies recognize that some or all of the incentive-based 
compensation awarded to a senior executive officer or significant risk-
taker may be forfeited before it vests. For an example of how these 
requirements would work in practice, please see Appendix A of this 
Supplementary Information section.
    This restriction is intended to prevent covered institutions from 
defeating the purpose of the deferral requirement by allowing vesting 
of most of the required deferral amounts immediately after the award 
date. In addition, the proposed approach aligns with both what the 
Agencies understand is common practice in the industry and with the 
requirements of many foreign supervisors.
Acceleration of Payments
    The Agencies propose that the acceleration of vesting and 
subsequent payment of incentive-based compensation that is required to 
be deferred under this proposed rule generally be prohibited for 
covered persons at Level 1 and Level 2 covered institutions. This 
restriction would apply to all deferred incentive-based compensation 
required to be deferred under the proposed rule, whether it was awarded 
as qualifying incentive-based compensation or under a long-term 
incentive plan. This prohibition on acceleration would not apply to 
compensation that the employee or the employer elects to defer in 
excess of the amounts required under the proposed rule or for time 
periods that exceed the required deferral periods or in certain other 
limited circumstances, such as the death or disability of the covered 
person.
    NCUA's proposed rule would permit acceleration of payment if 
covered persons at credit unions were subject to income taxes on the 
entire amount of an incentive-based compensation award even before 
deferred amounts vest. Incentive-based compensation for executives of 
not-for-profit entities is subject to income taxation under a different 
provision of the Internal Revenue Code \140\ than that applicable to 
executives of other covered institutions. The result is that credit 
union executives' incentive-based compensation awards may be subject to 
immediate taxation on the entire award, even deferred amounts.\141\ The 
ability to accelerate payment would be a limited exception only 
applicable to income tax liability and would only apply to the extent 
credit union executives must pay income tax on unvested amounts during 
the deferral period. Also, any amounts advanced to pay income tax 
liabilities for deferrals must be taken in proportion to the vesting 
schedule. For example, a credit union executive may have deferrals of 
$200,000 for each of three years ($600,000 total) and a total tax 
liability of $240,000 for the deferred amount of an award. The advanced 
tax

[[Page 37719]]

payments would result in an annual reduction of $80,000 per deferred 
payment, resulting in a new vesting amount of $120,000 for each year of 
the deferral period.
---------------------------------------------------------------------------

    \140\ 26 U.S.C. 457(f).
    \141\ The Agencies understand that the taxation of unvested 
deferred awards of covered persons at other covered institutions is 
based on other provisions of the Internal Revenue Code. See, e.g., 
26 U.S.C. 409A.
---------------------------------------------------------------------------

    Many institutions currently allow for accelerated vesting in the 
case of death or disability. Some current incentive-based compensation 
arrangements, such as separation agreements, between covered persons 
and covered institutions provide for accelerated vesting and payment of 
deferred incentive-based compensation that has not yet vested upon the 
occurrence of certain events.\142\ Many institutions also currently 
provide for the accelerated vesting of deferred incentive-based 
compensation awarded to their senior executive officers, particularly 
compensation awarded in the form of equity, in connection with a change 
in control of the company \143\ (sometimes as part of a ``golden 
parachute''). Shareholder proxy firms and some institutional investors 
have raised concerns about such golden parachutes,\144\ and golden 
parachutes are restricted by law under certain circumstances, including 
if an institution is in troubled condition.\145\ Finally, in current 
incentive-based compensation arrangements, events triggering 
acceleration commonly include leaving the employment of a covered 
institution for a new position (either any new position or only certain 
new positions, such as employment at a government agency), an 
acquisition or change in control of the covered institution, or upon 
the death or disability of the employee.\146\
---------------------------------------------------------------------------

    \142\ Several commenters argued that the 2011 Proposed Rule's 
deferral requirements should not apply upon the death, disability, 
retirement, or acceptance of government employment of covered 
persons, or a change in control of the covered institution, 
effectively arguing for the ability of covered institutions to 
accelerate incentive-based compensation under these circumstances.
    \143\ See, e.g., Equilar, ``Change-in-Control Equity 
Acceleration Triggers'' (March 19, 2014), available at http://www.equilar.com/reports/8-change-in-control-equity-acceleration-triggers.html (Noting that although neither Institutional 
Shareholder Services (ISS) nor Glass Lewis state that a single 
trigger plan will automatically result in an ``against'' 
recommendation, both make it clear that they view the single versus 
double trigger issue as an important factor in making their 
decisions. ISS, in particular, suggests in its policies that double 
trigger vesting of equity awards is currently the best market 
practice).
    \144\ Institutional Shareholders Services, ``2015 U.S. 
Compensation Policies, Frequently Asked Questions'' (February 9, 
2015) (``ISS Compensation FAQs''), available at https://www.issgovernance.com/file/policy/2015-us-comp-faqs.pdf; and 
Institutional Shareholders Services, ``U.S. Corporate Governance 
Policy: 2013 Updates'' (November 16, 2012), available at https://www.issgovernance.com/file/files/2013USPolicyUpdates.pdf.
    \145\ See 12 U.S.C. 1828(k) and 12 CFR part 359 (generally 
applicable to banks and holding companies).
    \146\ See, e.g., 2012 James F. Reda & Associates, ``Study of 
Executive Termination Provisions Among Top 200 Public Companies 
(December 2012), available at www.jfreda.com; Equilar, ``Change-in-
Control Equity Acceleration Triggers'' (March 19, 2014), available 
athttp://www.equilar.com/reports/8-change-in-control-equity-acceleration-triggers.html.
---------------------------------------------------------------------------

    The Federal Banking Agencies have found that the acceleration of 
deferred incentive-based compensation to covered persons is generally 
inappropriate because it weakens the balancing effect of deferral and 
eliminates the opportunity for forfeiture during the deferral period as 
information concerning risks taken during the performance period 
becomes known. The acceleration of vesting and payment of deferred 
incentive-based compensation in other circumstances, such as when the 
covered person voluntarily leaves the institution, could also provide 
covered persons with an incentive to retire or leave a covered 
institution if the covered person is aware of risks posed by the 
covered person's activities that are not yet apparent to or fully 
understood by the covered institution. Acceleration of payment could 
skew the balance of risk-taking incentives provided to the covered 
person if the circumstances under which acceleration is allowed are 
within the covered person's control. The proposed rule would prohibit 
acceleration of deferred compensation that is required to be deferred 
under this proposed rule in most circumstances given the potential to 
undermine risk balancing mechanisms.
    In contrast, the circumstances under which the Agencies would allow 
acceleration of payment, namely death or disability of the covered 
person, generally are not subject to the covered person's control, and, 
therefore, are less likely to alter the balance of risk-taking 
incentives provided to the covered person. In other cases where 
acceleration is permitted, effective governance and careful assessment 
of potential risks, as well as specific facts and circumstances are 
necessary in order to protect against creating precedents that could 
undermine more generally the risk balancing effects of deferral. 
Therefore, the Agencies have proposed to permit only these limited 
exceptions.
    Under the proposed rule, the prohibition on acceleration except in 
cases of death or disability would apply only to deferred amounts that 
are required by the proposed rule so as not to discourage additional 
deferral, or affect institutions that opt to defer incentive-based 
compensation exceeding the requirements. For example, if an institution 
defers compensation until retirement as a retention tool, but the 
institution then merges into another company and ceases to exist, 
retention may not be a priority. Thus, acceleration would be permitted 
for any deferred incentive-based compensation amounts above the amount 
required to be deferred or that was deferred longer than the minimum 
deferral period to allow those amounts to be paid out closer in time to 
the merger.
    Similarly, the acceleration of payment NCUA's rule permits if a 
covered person of a credit union faces up-front income tax liability on 
the deferred amounts of an award is not an event subject to the covered 
person's control. This exception will not apply unless the covered 
person is actually subject to income taxes on deferred amounts for 
which the covered person has not yet received payment, and equalizes 
the effect of deferral for covered persons at credit unions and covered 
persons at most other covered institutions. This limited exception is 
not intended to alter the balance of risk-taking incentives.
Qualifying Incentive-Based Compensation and Incentive-Based 
Compensation Awarded Under a Long-Term Incentive Plan
    The minimum required deferral amounts would be calculated 
separately for qualifying incentive-based compensation and incentive-
based compensation awarded under a long-term incentive plan, and those 
amounts would be required to be deferred for different periods of time. 
For the purposes of calculating qualifying incentive-based compensation 
awarded for any performance period, a covered institution would 
aggregate incentive-based compensation awarded under any incentive-
based compensation plan that is not a long-term incentive plan. The 
required deferral percentage (40, 50, or 60 percent) would be 
multiplied by that total amount to determine the minimum deferral 
amount. In a given year, if a senior executive officer or significant 
risk-taker is awarded qualifying incentive-based compensation under 
multiple plans that have the same performance period (which is less 
than three years), the award under each plan would not be required to 
meet the minimum deferral requirement, so long as the total amount that 
is deferred from all of the amounts awarded under those plans meets the 
minimum required percentage of total qualifying incentive-based 
compensation relevant to that covered person.

[[Page 37720]]

    For example, under the proposal, a significant risk-taker at a 
Level 2 covered institution might be awarded $60,000 under a plan with 
a one-year performance period that applies to all employees in her line 
of business and $40,000 under a plan with a one-year performance period 
that applies to all employees of the covered institution. For that 
performance period, the significant risk-taker has been awarded a total 
of $100,000 in qualifying incentive-based compensation, so she would be 
required to defer a total of $40,000. The covered institution could 
defer amounts awarded under either plan or under both plans, so long as 
the total amount deferred was at least $40,000. For example, the 
covered institution could choose to defer $20,000 from the first plan 
and $20,000 from the second plan. The covered institution could also 
choose to defer nothing awarded under the first plan and the entire 
$40,000 awarded under the second plan.
    For a full example of how these requirements would work in the 
context of a more complete incentive-based compensation arrangement, 
please see Appendix A of this preamble.
    In contrast, the minimum required deferral percentage would apply 
to all incentive-based compensation awarded under each long-term 
incentive plan separately. In a given year, if a senior executive 
officer or significant risk-taker is awarded incentive-based 
compensation under multiple long-term incentive plans that have 
performance periods of three years or more, each award under each plan 
would be required to meet the minimum deferral requirement.\147\ Based 
on supervisory experience, the Federal Banking Agencies have found that 
it would be extremely rare for a covered person to be awarded 
incentive-based compensation under multiple long-term incentive plans 
in one year.
---------------------------------------------------------------------------

    \147\ For example, if a Level 1 covered institution awarded a 
senior executive officer $100,000 under one long-term incentive plan 
and $200,000 under another long-term incentive-plan, the covered 
institution would be required to defer at least $60,000 of the 
amount awarded under the first long-term incentive plan and at least 
$120,000 of the amount awarded under the second long-term incentive 
plan. The Level 1 covered institution would not be permitted to meet 
the deferral requirements by deferring, for example, $10,000 awarded 
under the first long-term incentive plan and $170,000 awarded under 
the second long-term incentive plan.
---------------------------------------------------------------------------

    The proposed rule would require deferral for the same percentage of 
qualifying incentive-based compensation as of incentive-based 
compensation awarded under a long-term incentive plan. However, the 
proposed rule would require that deferred qualifying incentive-based 
compensation meet a longer minimum deferral period than deferred 
incentive-based compensation awarded under a long-term incentive plan. 
As with the shorter performance period for qualifying incentive-based 
compensation, the period over which performance is measured under a 
long-term incentive plan is not considered part of the deferral period.
    Under the proposed rule, both deferred qualifying incentive-based 
compensation and deferred incentive-based compensation awarded under a 
long-term incentive plan would be required to meet the vesting 
requirements separately. In other words, deferred qualifying incentive-
based compensation would not be permitted to vest faster than on a on a 
pro rata annual basis, even if deferred incentive-based compensation 
awarded under a long-term incentive plan vested on a slower than pro 
rata basis. Each deferred portion is bound by the pro rata requirement.
    For an example of how these requirements would work in practice, 
please see Appendix A of this Supplementary Information section.
    Incentive-based compensation provides an inducement for a covered 
person at a covered institution to advance the strategic goals and 
interests of the covered institution while enabling the covered person 
to share in the success of the covered institution. Incentive-based 
compensation may also encourage covered persons to take undesirable or 
inappropriate risks, or to sell unsuitable products in the hope of 
generating more profit and thereby increasing the amount of incentive-
based compensation received. Covered persons may also be tempted to 
manipulate performance results in an attempt to make performance 
measurements look better or to understate the actual risks such 
activities impose on the covered institution's balance sheet.\148\ 
Incentive-based compensation should therefore also provide incentives 
for prudent risk-taking in the long term and for sound risk management.
---------------------------------------------------------------------------

    \148\ For example, towards the end of the performance period, 
covered persons who have not yet met the target performance measures 
could be tempted to amplify risk taking or take other actions to 
meet those targets and receive the maximum incentive-based 
compensation. Without deferral, there would be no additional review 
applied to the risk-taking activities that were taken during the 
defined performance period to achieve those target performance 
measures.
---------------------------------------------------------------------------

    Deferral of incentive-based compensation awards involves a delay in 
the vesting and payout of an award to a covered person beyond the end 
of the performance period. The deferral period allows for amounts of 
incentive-based compensation to be adjusted for actual losses to the 
covered institution or for other aspects of performance that become 
clear during the deferral period before those amounts vest or are paid. 
These aspects include inappropriate risk-taking and misconduct on the 
part of the covered person. More generally, deferral periods that 
lengthen the time between the award of incentive-based compensation and 
vesting, combined with forfeiture, are important tools for aligning the 
interests of risk-takers with the longer-term interests of covered 
institutions.\149\ Deferral periods that are sufficiently long to allow 
for a substantial portion of the risks from the covered person's 
activities to manifest are likely to be most effective in ensuring that 
risks and rewards are adequately balanced.\150\
---------------------------------------------------------------------------

    \149\ There have been a number of academic papers that argue 
that deferred compensation provides incentives for executives to 
consider the long-term health of the firm. For example, Eaton and 
Rosen (1983) note that delaying compensation is a way of bonding 
executives to the firm and providing incentives for them to focus on 
long-term performance of the firm. See Eaton and Rosen, ``Agency, 
Delayed Compensation, and the Structure of Executive Remuneration,'' 
38 Journal of Finance 1489, at 1489-1505; see also Park and Sturman, 
``How and What You Pay Matters: The Relative Effectiveness of Merit 
Pay, Bonus, and Long-Term Incentives on Future Job Performance'' 
(2012), available at http://scholarship.sha.cornell.edu/cgi/viewcontent.cgi?article=1121&context=articles.
    \150\ The length of the deferral period has been a topic of 
discussion in the literature. Edmans (2012) argues that deferral 
periods of two to three years are too short. He also argues that 
deferral should be longer for institutions where the decisions of 
the executives have long-term consequences. Bebchuk et al (2010) 
argue that deferral provisions alone will not prevent executives 
from putting emphasis on short-term prices because executives that 
have been in place for many years will have the opportunity to 
regularly cash out. They argue that executives should be required to 
hold a substantial number of shares and options until retirement. 
See also Edmans, Alex, ``How to Fix Executive Compensation,'' The 
Wall Street Journal (February 27, 2012); Bebchuk, Lucian, Cohen, and 
Spamann, ``The Wages of Failure: Executive Compensation at Bear 
Stearns and Lehman 2000-2008,'' 27 Yale Journal on Regulation 257, 
257-282 (2010); Bhagat, Sanjai, Bolton and Romano, ``Getting 
Incentives Right: Is Deferred Bank Executive Compensation 
Sufficient?,'' 31 Yale Journal on Regulation 523 (2014); Bhagat, 
Sanjai and Romano, ``Reforming Financial Executives' Compensation 
for the Long Term,'' Research Handbook on Executive Pay (2012); 
Bebchuk and Fried, ``Paying for Long-Term Performance,'' 158 
University of Pennsylvania Law Review, 1915 (2010).
---------------------------------------------------------------------------

    Deferral periods allow covered institutions an opportunity to more 
accurately judge the nature and scale of risks imposed on covered 
institutions' balance sheets by a covered person's performance for 
which incentive-based compensation has been awarded, and to better 
understand and identify risks that

[[Page 37721]]

result from such activities as they are realized. These include risks 
imposed by inappropriate risk-taking or misconduct, and risks that may 
manifest as a result of lapses in risk management or risk oversight. 
For example, the risks associated with some business lines, such as 
certain types of lending, may require many years before they 
materialize.
    Though it is difficult to set deferral periods that perfectly match 
the time it takes risks undertaken by the covered persons of covered 
institutions to become known, longer periods allow more time for 
incentive-based compensation to be adjusted between the time of award 
and the time incentive-based compensation vests.\151\ At the same time, 
deferral periods that are inordinately long may reduce the 
effectiveness of incentive-based compensation arrangements because 
employees more heavily discount the potential impact of such 
arrangements. Thus, it is important to strike a reasonable balance 
between providing effective incentives and allowing sufficient time to 
validate performance measures over a reasonable period of deferral. The 
specific deferral periods and amounts proposed in the proposed rule are 
also consistent with current practice at many institutions that would 
be Level 1 or Level 2 covered institutions, and with compensation 
requirements in other countries.\152\ In drafting the requirements in 
sections __.7(a)(1) and __.7(a)(2), the Agencies took into account the 
comments received regarding similar requirements in the 2011 Proposed 
Rule.\153\
---------------------------------------------------------------------------

    \151\ Some empirical literature has found a link between the 
deferral of compensation and firm value, firm performance, risk, and 
the manipulation of earnings. Gopalan et al (2014) measure the 
duration of executive compensation by accounting for the vesting 
schedules in compensation. They argue that the measure is a proxy 
for the executives' horizon. They find that longer duration of 
compensation is present at less risky institutions and institutions 
with better past stock performance. They also find that longer 
duration is associated with less manipulation of earnings. Chi and 
Johnson (2009) find that longer vesting periods for stocks and 
options are related to higher firm value. See Gopalan, 
Radhakrishnan, Milbourn, Song and Thakor, ``Duration of Executive 
Compensation,'' 59 The Journal of Finance 2777 (2014); Chi, Jianxin, 
and Johnson, ``The Value of Vesting Restrictions on Managerial Stock 
and Option Holdings'' (March 9, 2009) available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1136298.
    \152\ Moody's Investor Service, ``Global Investment Banks: 
Reformed Pay Policies Still Pose Risks to Bondholders'' (``Moody's 
Report'') (December 9, 2014); McLagan, ``Mandatory Deferrals in 
Incentive Programs'' (March 2013), available at http://www.mclagan.com/crb/downloads/McLagan_Mandatory_Deferral_Flash_Survey_Report_3-29-2013.pdf.
    \153\ Commenters on the 2011 Proposed Rule expressed differing 
views on the proposed deferral requirements and the deferral-related 
questions posed by the Agencies. For example, some commenters 
expressed the view that the deferral requirements for incentive-
based compensation awards for executive officers were appropriate. 
Some commenters argued that deferral would create a longer-term 
focus for executives and help to ensure they are not compensated on 
the basis of short-term returns that fail to account for long-term 
risks. Many commenters also argued that the deferral requirements 
should be strengthened by extending the required minimum deferral 
period or minimum percentage of incentive compensation deferred. For 
example, these commenters urged the Agencies to require a five-year 
deferral period, instead of the three-year period that was proposed, 
or to disallow ``pro rata'' payments within the proposed three-year 
deferral period. These commenters also expressed the view that the 
Agencies' proposal to require covered financial institutions to 
defer 50 percent of their annual compensation would result in an 
insufficient amount of incentive-based compensation being at risk of 
potential adjustment, because the risks posed by those executive 
officer can take longer to become apparent. Other commenters argued 
that all covered institutions subject to this rulemaking should 
comply with the deferral requirements regardless of their size.
    On the other hand, many commenters recommended that deferral not 
be required or argued that, if deferral were to be required, the 
three-year and 50 percent deferral minimums provided in the 2011 
Proposed Rule were sufficient. Some commenters recommended that the 
deferral requirements not be applied to smaller covered 
institutions. Some commenters also suggested that unique aspects of 
certain types of covered institutions, such as investment advisers 
or smaller banks within a larger consolidated organization, should 
be considered when imposing deferral and other requirements on 
incentive-based compensation arrangements. A number of commenters 
suggested that applying a prescriptive deferral requirement, 
together with other requirements under the 2011 Proposed Rule, would 
make it more difficult for covered institutions to attract and 
retain key employees in comparison to the ability of organizations 
not subject to such requirements to recruit and retain the same 
employees.
---------------------------------------------------------------------------

    The Agencies have proposed the three- and four-year minimum 
deferral periods because these deferral periods, taken together with 
the typically one-year performance period, would allow a Level 1 or 
Level 2 covered institution four to five years, or the majority of a 
traditional business cycle, to identify outcomes associated with a 
senior executive officer's or significant risk-taker's performance and 
risk-taking activities. The business cycle reflects periods of economic 
expansion or recession, which typically underpin the performance of the 
financial sector. The Agencies recognize that credit cycles, which 
revolve around access to and demand for credit and are influenced by 
various economic and financial factors, can be longer.\154\
---------------------------------------------------------------------------

    \154\ From 1945 to 2009, the average length of the business 
cycle in the U.S. was approximately 5.7 years. See The National 
Bureau of Economic Research, ``U.S. Business Cycle Expansions and 
Contractions, available at http://www.nber.org/cycles/cyclesmain.html. Many researchers have found that credit cycles are 
longer than business cycles. For example, Drehmann et al (2012) 
estimate an average duration of credit cycles from 10 to 20 years. 
See Drehmann, Mathias, Borio and Tsatsaronis, ``Characterising the 
Financial Cycle: Don't Lose Sight of the Medium Term!'' Bank for 
International Settlements, Working Paper, No. 380 (June 2012), 
available at http://www.bis.org/publ/work380.htm. Aikman et al 
(2015) found that the credit cycle ranges from eight to 20 years. 
See Aikman, Haldane, and Nelson, ``Curbing the Credit Cycle,'' 125 
The Economic Journal 1072 (June 2015).
---------------------------------------------------------------------------

    However, the Agencies are also concerned with striking the right 
balance between allowing covered persons to be fairly compensated and 
not encouraging inappropriate risk-taking. The Agencies are concerned 
that extending deferral periods for too long may lead to a covered 
person placing little or no value on the incentive-based compensation 
that only begins to vest far out in the future. This type of 
discounting of the value of long-deferred awards may be less effective 
as an incentive, positive or negative, and consequently for balancing 
the benefit of these types of awards.\155\
---------------------------------------------------------------------------

    \155\ See Pepper and Gore, ``The Economic Psychology of 
Incentives: An International Study of Top Managers,'' 49 Journal of 
World Business 289 (2014); PRA, Consultation Paper PRA CP15/14/FCA 
CP14/14: Strengthening the alignment of risk and reward: new 
remuneration rules (July 2014) available at http://www.bankofengland.co.uk/pra/Documents/publications/cp/2014/cp1514.pdf.
---------------------------------------------------------------------------

    As described above, since the Agencies proposed the 2011 Proposed 
Rule, the Agencies have gained significant supervisory experience while 
encouraging covered institutions to adopt improved incentive-based 
compensation practices. The Federal Banking Agencies note in particular 
improvements in design of incentive-based compensation arrangements 
that help to more appropriately balance risk and reward. Regulatory 
requirements for sound incentive-based compensation arrangements at 
financial institutions have continued to evolve, including those being 
implemented by foreign regulators. Consideration of international 
practices and standards is particularly relevant in developing 
incentive-based compensation standards for large financial institutions 
because they often compete for talented personnel internationally.
    Based on supervisory experience, although exact amounts deferred 
may vary across employee populations at large covered institutions, the 
Federal Banking Agencies have observed that, since the financial crisis 
that began in 2007, most deferral periods at financial institutions 
range from three to five years, with three years being the most common 
deferral period.\156\ Consistent with this observation, the FSB 
standards suggest deferral periods ``not less than

[[Page 37722]]

three years,'' and the average deferral period at significant 
institutions in FSB member countries is now between three and four 
years.\157\ The PRA requires deferral of seven years for senior 
managers as defined under the Senior Managers Regime, five years for 
risk managers as defined under the EBA regulatory technical standard on 
identification of material risk-takers, and three to five years as per 
the CRD IV minimum for all other material risk-takers.\158\ CRD IV sets 
a minimum deferral period of ``at least three to five years.'' For 
senior management, significant institutions \159\ are expected to apply 
deferral of ``at least five years.'' \160\ Swiss regulations \161\ 
require that for members of senior management, persons with relatively 
high total remuneration, and persons whose activities have a 
significant influence on the risk profile of the firm, the time period 
for deferral should last ``at least three years.''
---------------------------------------------------------------------------

    \156\ See 2011 FRB White Paper, at 15.
    \157\ FSB, Implementing the FSB Principles for Sound 
Compensation Practices and their Implementation Standards: Fourth 
Progress Report (``2015 FSB Compensation Progress Report'') (2015), 
available at http://www.fsb.org/2015/11/fsb-publishes-fourth-progress-report-on-compensation-practices.
    \158\ See UK Remuneration Rules. The United Kingdom deferral 
standards apply on a group-wide basis and apply to banks, building 
societies, and PRA-designated investment firms, but do not currently 
cover investment advisors outside of consolidated firms.
    \159\ CRD IV defines institutions that are significant ``in 
terms of size, internal organisation and nature, scope and 
complexity of their activities.'' Under the EBA Guidance on Sound 
Remuneration Policies, significant institutions means institutions 
referred to in Article 131 of Directive 2013/36/EU (global 
systemically important institutions or `G-SIIs,' and other 
systemically important institutions or `O-SIIs'), and, as 
appropriate, other institutions determined by the competent 
authority or national law, based on an assessment of the 
institutions' size, internal organisation and the nature, the scope 
and the complexity of their activities. Some, but not all, national 
regulators have provided further guidance on interpretation of that 
term, including the FCA which provides a form of methodology to 
determine if a firm is ``significant'' based on quantitative tests 
of balance sheet assets, liabilities, annual fee commission income, 
client money and client assets.
    \160\ See EBA Remuneration Guidelines.
    \161\ See FINMA Remuneration Circular 2010.
---------------------------------------------------------------------------

    The requirements in the proposed rule regarding amounts deferred 
are also consistent with observed better practices and the standards 
established by foreign regulators. The Board's summary overview of 
findings during the early stages of the 2011 FRB White Paper \162\ 
observed that ``deferral fractions set out in the FSB Principles and 
Implementation Standards \163\ are sometimes used as a benchmark (60 
percent or more for senior executives, 40 percent or more for other 
individual ``material risk takers,'' which are not the same as 
``covered employees'') and concluded that deferral fractions were at or 
above these benchmarks at both the U.S. banking organizations and 
foreign banking organizations that participated in the horizontal 
review.
---------------------------------------------------------------------------

    \162\ See FRB 2011 Report, at 31.
    \163\ Specifically, the FSB Implementation Standards encourage 
that ``a substantial portion of variable compensation, such as 40 to 
60 percent, should be payable under deferral arrangements over a 
period of years'' and that ``proportions should increase 
significantly along with the level of seniority and/or 
responsibility . . . for the most senior management and the most 
highly paid employees, the percentage of variable compensation that 
is deferred should be substantially higher, for instance, above 60 
percent.''
---------------------------------------------------------------------------

    The proportion of incentive-based compensation awards observed to 
be deferred at financial institutions during the Board's horizontal 
review was substantial. For example, on average senior executives 
report more than 60 percent of their incentive-based compensation is 
deferred,\164\ and some of the most senior executives had more than 80 
percent of their incentive-based compensation deferred with additional 
stock retention requirements after deferred stock vests. Most 
institutions assigned deferral rates to employees using a fixed 
schedule or ``cash/stock table'' under which employees that received 
higher incentive-based compensation awards generally were subject to 
higher deferral rates, although deferral rates for the most senior 
executives were often set separately and were higher than those for 
other employees.\165\ The proposed rule's higher deferral rates for 
senior executive officers would be consistent with this observed 
industry practice of requiring higher deferral rates for the most 
senior executives. Additionally, by their very nature, senior executive 
officer positions tend to have more responsibility for strategic 
decisions and oversight of multiple areas of operations, and these 
responsibilities warrant requiring higher percentages of deferral and 
longer deferral periods to safeguard against inappropriate risk-taking.
---------------------------------------------------------------------------

    \164\ ``Deferral'' for these reports is defined by the 
institutions and may include long-term incentive plans without 
additional deferral.
    \165\ See 2011 FRB White Paper, at 15.
---------------------------------------------------------------------------

    This proposed rule is also consistent with standards being 
developed internationally. The PRA expects that ``where any employee's 
variable remuneration component is [pound]500,000 or more, at least 60 
percent should be deferred.'' \166\ European Union regulations require 
that ``institutions should set an appropriate portion of remuneration 
that should be deferred for a category of identified staff or a single 
identified staff member at or above the minimum proportion of 40 
percent or respectively 60 percent for particularly high amounts.'' 
\167\ The EU also publishes a report on Benchmarking of Remuneration 
Practices at Union Level and Data on High Earners \168\ that provides 
insight into amounts deferred across various lines of business within 
significant institutions across the European Union. While amounts 
varied by areas of operations, average deferral levels for identified 
staff range from 54 percent in retail banking to more than 73 percent 
in investment banking.
---------------------------------------------------------------------------

    \166\ See PRA, Supervisory Statement SS27/15: Remuneration (June 
2015), available at http://www.bankofengland.co.uk/pra/Documents/publications/ss/2015/ss2715.pdf.
    \167\ See EBA Remuneration Guidelines.
    \168\ See, e.g., EBA, Benchmarking of Remuneration Practices at 
Union Level and Data on High Earners, at 39, Figure 46 (September 
2015), available at http://www.eba.europa.eu/-/eba-updates-on-remuneration-practices-and-high-earners-data-for-2013-across-the-eu.
---------------------------------------------------------------------------

    The proposed rule's enhanced requirements for Level 1 institutions 
are consistent with international standards. Many regulators apply 
compensation standards in a proportional or tiered fashion. The PRA, 
for example, classifies three tiers of firms based on asset size and 
applies differentiated standards across this population. 
Proportionality Level 1 includes firms with greater than [pound]50 
billion in consolidated assets; Proportionality Level 2 includes firms 
with between [pound]15 billion and [pound]50 billion in consolidated 
assets; and Proportionality Level 3 includes firms with less than 
[pound]15 billion in consolidated assets. The PRA also recognizes 
``significant'' firms. Proportionality Level 3 firms are typically not 
subject to provisions on retained shares, deferral, or performance 
adjustment.
    Under the proposed rule, incentive-based compensation awarded under 
a long-term incentive plan would be treated separately and differently 
than amounts of incentive-based compensation awarded under annual 
performance plans (and other qualifying incentive-based compensation) 
for the purposes of the deferral requirements. Deferral of incentive-
based compensation and the use of longer performance periods (which is 
the hallmark of a long-term incentive plan) both are useful tools for 
balancing risk and reward in incentive-based compensation arrangements 
because both allow for the passage of time that allows the covered 
institution to have more information about a covered person's risk-
taking activity and its possible outcomes. Both methods allow

[[Page 37723]]

awards or payments to be made after some or all risk outcomes are 
realized or better known. However, longer performance periods and 
deferral of vesting are distinct risk balancing methods.\169\
---------------------------------------------------------------------------

    \169\ The 2011 Proposed Rule expressly recognized this 
distinction (``The Proposed Rule identifies four methods that 
currently are often used to make compensation more sensitive to 
risk. These methods are Risk Adjustment of Awards . . . Deferral of 
Payment . . . Longer Performance Periods . . . Reduced Sensitivity 
to Short-Term Performance.''). See 76 FR at 21179.
---------------------------------------------------------------------------

    As noted above, the Agencies took into account the comments 
received regarding similar deferral requirements in the 2011 Proposed 
Rule. In response to the proposed deferral requirement in the 2011 
Proposed Rule, which did not distinguish between incentive-based 
compensation awarded under a long-term incentive plan and other 
incentive-based compensation, several commenters argued that the 
Agencies should allow incentive-based compensation arrangements that 
use longer performance periods, such as a three-year performance 
period, to count toward the mandatory deferral requirement. In 
particular, some commenters argued that institutions that use longer 
performance periods should be allowed to start the deferral period at 
the beginning of the performance period. In this way, they argued, a 
payment made at the end of a three-year performance period has already 
been deferred for three years for the purposes of the deferral 
requirement.
    As discussed above, deferral allows for time to pass after the 
conclusion of the performance period. It introduces a period of time in 
between the end of the performance period and vesting of the incentive-
based compensation during which risks may mature without the employee 
taking additional risks to affect that earlier award.
    Currently, institutions commonly use long-term incentive plans 
without subsequent deferral and thus there is no period following the 
multi-year performance period that would permit the covered institution 
to apply forfeiture or other reductions should it become clear that the 
covered person engaged in inappropriate risk-taking. Without deferral, 
the incentive-based compensation is awarded and vests at the end of the 
multi-year performance period.\170\ In contrast, during the deferral 
period, the covered person's incentive-based compensation award is 
fixed and the vesting could be affected by information about a covered 
person's risk-taking activities during the performance period that 
becomes known during the deferral period.
---------------------------------------------------------------------------

    \170\ An employee may be incentivized to take additional risks 
near the end of the performance period to attempt to compensate for 
poor performance early in the period of the long-term incentive 
compensation plan. For example, as noted above, towards the end of a 
multi-year performance period, covered persons who have not yet met 
the target performance measures could be tempted to amplify risk 
taking or take other actions to meet those targets and receive the 
maximum long-term incentive plan award with no additional review 
applied to the risk-taking activities that were taken during the 
defined performance period to achieve those target performance 
measures.
---------------------------------------------------------------------------

    For a long-term incentive plan, the period of time between the 
beginning of the performance period and when incentive-based 
compensation is awarded is longer than that of an annual plan. However, 
the period of time between the end of the performance period and when 
incentive-based compensation is awarded is the same for both the long-
term incentive plan and for the annual plan. Consequently, while a 
covered institution may have more information about the risk-taking 
activities of a covered person that occurred near the beginning of the 
performance period for a long-term incentive plan than for an annual 
plan, the covered institution would have no more information about 
risk-taking activities that occur near the end of the performance 
period. The incentive-based compensation awarded under the long-term 
incentive plan would be awarded without the benefit of additional 
information about risk-taking activities near the end of the 
performance period.
    Therefore, the proposed rule would treat incentive-based 
compensation awarded under a long-term incentive plan similarly to, but 
not the same as, qualifying incentive-based compensation for purposes 
of the deferral requirement. Under the proposed rule, the incentive-
based compensation awarded under a long-term incentive plan would be 
required to be deferred for a shorter amount of time than qualifying 
incentive-based compensation, although the period of time elapsing 
between the beginning of the performance period and the actual vesting 
would be longer. A shorter deferral period would recognize the fact 
that the longer performance period of a long-term incentive plan allows 
some time for information to surface about risk-taking activities 
undertaken at the beginning of the performance period. The longer 
performance period allows covered institutions to adjust the amount 
awarded under long-term incentive plans for poor performance during the 
performance period. Yet, since no additional time would pass between 
risk-taking activities at the end of the performance period and the 
award date, the proposed rule would allow a shorter deferral period 
than would be necessary for qualifying incentive-based compensation.
    The percentage of incentive-based compensation awarded that would 
be required to be deferred would be the same for incentive-based 
compensation awarded under a long-term incentive plan and for 
qualifying incentive-based compensation. However, because of the 
difference in the minimum required deferral period, the minimum 
deferral amounts for qualifying incentive-based compensation and for 
incentive-based compensation awarded under a long-term incentive plan 
would be required to be calculated separately. In other words, any 
amount of qualifying incentive-based compensation that a covered 
institution chooses to defer above the minimum required would not 
decrease the minimum amount of incentive-based compensation awarded 
under a long-term plan that would be required to be deferred, and vice 
versa.
    For example, a Level 2 covered institution that awards a senior 
executive officer $50,000 of qualifying incentive-based compensation 
and $20,000 under a long-term incentive plan would be required to defer 
at least $25,000 of the qualifying incentive-based compensation and at 
least $10,000 of the amounts awarded under the long-term incentive 
plan. The Level 2 covered institution would not be permitted to defer, 
for example, $35,000 of qualifying incentive-based compensation and no 
amounts awarded under the long-term incentive plan, even though that 
would result in the deferral of 50 percent of the senior executive 
officer's total incentive-based compensation. For a full example of how 
these requirements would work in the context of a more complete 
incentive-based compensation arrangement, please see Appendix A of this 
preamble.
    For incentive-based compensation awarded under a long-term 
incentive plan, section __.7(a)(2) of the proposed rule would require 
that minimum deferral periods for senior executive officers and 
significant risk-takers at a Level 1 covered institution extend to two 
years after the award date and minimum deferral periods at a Level 2 
covered institution extend to one year after the award date. For long-
term incentive plans with performance periods of three years,\171\ this

[[Page 37724]]

requirement would delay the vesting of the last portion of this 
incentive-based compensation until five years after the beginning of 
the performance period at Level 1 covered institutions and four years 
after the beginning of the performance period at Level 2 covered 
institutions. Thus, while the deferral period from the award date is 
shorter for incentive-based compensation awarded under a long-term 
incentive plan, the delay in vesting from the beginning of the 
performance period would generally be the same under the most common 
qualifying incentive-based compensation and long-term incentive plans.
---------------------------------------------------------------------------

    \171\ Many studies of incentive-based compensation at large 
institutions have found that long-term incentive plans commonly have 
performance periods of three years. See Cook Report; Moody's Report.
---------------------------------------------------------------------------

    Under the proposed rule, the incentive-based compensation that 
would be required by the rule to be deferred would not be permitted to 
vest faster than on a pro rata annual basis beginning no earlier than 
the first anniversary of the end of the performance period. This 
requirement would apply to both deferred qualifying incentive-based 
compensation and deferred incentive-based compensation awarded under a 
long-term incentive plan.
    The Federal Banking Agencies have also observed that the minimum 
required deferral amounts and deferral periods that would be required 
under the proposed rule are generally consistent with industry practice 
at larger covered institutions that are currently subject to the 2010 
Federal Banking Agency Guidance, although the Agencies recognize that 
some institutions would need to revise their individual incentive-based 
compensation programs and others were not subject to the 2010 Federal 
Banking Agency Guidance. In part because the 2010 Federal Banking 
Agency Guidance and compensation regulations imposed by international 
regulators \172\ currently encourage banking institutions to increase 
the proportion of compensation that is deferred to reflect higher 
levels of seniority or responsibility, current practice for the largest 
international banking institutions reflects substantial levels of 
deferral for such individuals. Many of those individuals would be 
senior executive officers and significant risk-takers under the 
proposed rule. Under current practice, deferral typically ranges from 
40 percent for less senior significant risk-takers to more than 60 
percent for senior executives.\173\ The Agencies note that current 
practice for the largest international banking institutions reflects 
average deferral periods of at least three years.\174\
---------------------------------------------------------------------------

    \172\ Most members of the FSB, for instance, have issued 
regulations, or encourage through guidance and supervisory practice, 
deferral standards that meet the minimums set forth in the FSB's 
Implementation Standards. See 2015 FSB Compensation Progress Report 
(concluding ``almost all FSB jurisdictions have now fully 
implemented the P&S for banks.''). The FSB standards state that ``a 
substantial portion of variable compensation, such as 40 to 60 
percent, should be payable under deferral arrangements over a period 
of years and these proportions should increase significantly along 
with the level of seniority and/or responsibility. The deferral 
period should not be less than three years. See FSB Principles and 
Implementation Standards.
    \173\ FSB member jurisdictions provided data for the purposes of 
the 2015 FSB Compensation Progress Report indicating that while the 
percentage of variable remuneration deferred varies significantly 
between institutions and across categories of staff, for the 
surveyed population of senior executives, the percentage of deferred 
incentive-based compensation averaged approximately 50 percent. See 
2015 FSB Compensation Progress Report.
    \174\ See Moody's Report.
---------------------------------------------------------------------------

    The deferral requirements of the proposed rule for senior executive 
officers and significant risk-takers at the largest covered 
institutions are also consistent with international standards on 
compensation. The European Union's 2013 law on remuneration paid by 
financial institutions requires deferral for large firms, among other 
requirements.\175\ The PRA and the FCA initially adopted the European 
Union's law and requires covered companies to defer 40 to 60 percent of 
``senior manager,'' ``risk manager,'' and ``material risk-taker'' 
compensation. The PRA and FCA recently updated their implementing 
regulations to extend deferral periods to seven years for senior 
managers and up to five years for certain other persons.\176\ The 
proposed deferral requirements are also generally consistent with the 
FSB's Principles for Sound Compensation Practices and their related 
implementation standards issued in 2009.\177\ Having standards that are 
generally consistent across jurisdictions would be important both to 
enable institutions subject to multiple regimes to fulfill the 
requirements of all applicable regimes, and to ensure that covered 
institutions in the United States would be on a level playing field 
compared to their non-U.S. peers in the global competition for talent.
---------------------------------------------------------------------------

    \175\ In June 2013, the European Union adopted CRD IV, which 
sets out requirements on compensation structures, policies, and 
practices that applies to all banks and investment firms subject to 
the CRD. CRD IV provides that at least 50 percent of total variable 
remuneration should consist of equity-linked interests and at least 
40 percent of the variable component must be deferred over a period 
of three to five years. Directive 2013/36/EU of the European 
Parliament and of the Council of 26 June 2013 (effective January 1, 
2014).
    \176\ See UK Remuneration Rules. In the case of a material risk-
taker who performs a PRA senior management function, the pro rata 
vesting requirement applies only from year three onwards (i.e., the 
required deferral period is seven years, with no vesting to take 
place until three years after award).
    \177\ FSB Principles and Implementation Standards.
---------------------------------------------------------------------------

    7.1. The Agencies invite comment on the proposed requirements in 
sections __.7(a)(1) and (a)(2).
    7.2. Are minimum required deferral periods and percentages 
appropriate? If not, why not? Should Level 1 and Level 2 covered 
institutions be subject to different deferral requirements, as in the 
proposed rule, or should they be treated more similarly for this 
purpose and why? Should the minimum required deferral period be 
extended to, for example, five years or longer in certain cases and 
why?
    7.3. Is a deferral requirement for senior executive officers and 
significant risk-takers at Level 1 and Level 2 covered institutions 
appropriate to promote the alignment of employees' incentives with the 
risk undertaken by such covered persons? If not, why not? For example, 
comment is invited on whether deferral is generally an appropriate 
method for achieving incentive-based compensation arrangements that 
appropriately balance risk and reward for each type of senior executive 
officer and significant risk-taker at these institutions or whether 
there are alternative or more effective ways to achieve such balance.
    7.4. Commenters are also invited to address the possible impact 
that the required minimum deferral provisions for senior executive 
officers and significant risk-takers may have on larger covered 
institutions and whether any deferral requirements should apply to 
senior executive officers at Level 3 institutions.
    7.5. A number of commenters to the 2011 Proposed Rule suggested 
that applying a prescriptive deferral requirement, together with other 
requirements under that proposal, would make it more difficult for 
covered institutions to attract and retain key employees in comparison 
to the ability of organizations not subject to such requirements to 
recruit and retain the same employees. What implications does the 
proposed rule have on ``level playing fields'' between covered 
institutions and non-covered institutions in setting forth minimum 
deferral requirements under the rule?
    7.6. The Agencies invite comment on whether longer performance 
periods can provide risk balancing benefits similar to those provided 
by deferral, such that the shorter deferral periods for incentive-based 
compensation awarded under long-term incentive plans in the proposed 
rule would be appropriate.
    7.7. Would the proposed distinction between the deferral 
requirements for

[[Page 37725]]

qualifying incentive-based compensation and incentive-based 
compensation awarded under a long-term incentive plan pose practical 
difficulties for covered institutions or increase compliance burdens? 
Why or why not?
    7.8. Would the requirement in the proposed rule that amounts 
awarded under long-term incentive plans be deferred result in covered 
institutions offering fewer long-term incentive plans? If so, why and 
what other compensation plans will be used in place of long-term 
incentive plans and what negative or positive consequences might 
result?
    7.9. Are there additional considerations, such as tax or accounting 
considerations, that may affect the ability of Level 1 or Level 2 
covered institutions to comply with the proposed deferral requirement 
or that the Agencies should consider in connection with this provision 
in the final rule? Commenters on the 2011 Proposed Rule noted that 
employees of an investment adviser to a private fund hold partnership 
interests and that any incentive allocations paid to them are typically 
taxed at the time of allocation, regardless of whether these 
allocations have been distributed, and consequently, employees of an 
investment adviser to a private fund that would have been subject to 
the deferral requirement in the 2011 Proposed Rule would have been 
required to pay taxes relating to incentive allocations that they were 
required to defer. Should the determination of required deferral 
amounts under the proposed rule be adjusted in the context of 
investment advisers to private funds and, if so, how? Could the tax 
liabilities immediately payable on deferred amounts be paid from the 
compensation that is not deferred?
    7.10. The Agencies invite comment on the circumstances under which 
acceleration of payment should be permitted. Should accelerated vesting 
be allowed in cases where employees are terminated without cause or 
cases where there is a change in control and the covered institution 
ceases to exist and why? Are there other situations for which 
acceleration should be allowed? If so, how can such situations be 
limited to those of necessity?
    7.11. The Agencies received comment on the 2011 Proposed Rule that 
stated it was common practice for some private fund adviser personnel 
to receive payments in order to enable the recipients to make tax 
payments on unrealized income as they became due. Should this type of 
practice to satisfy tax liabilities, including tax liabilities payable 
on unrealized amounts of incentive-based compensation, be permissible 
under the proposed rule, including, for example, as a permissible 
acceleration of vesting under the proposed rule? Why or why not? Is 
this a common industry practice?

Sec.  __.7(a)(3) Adjustments of Deferred Qualifying Incentive-Based 
Compensation and Deferred Long-Term Incentive Plan Compensation Amounts

    Under section __.7(a)(3) of the proposed rule, during the deferral 
period, a Level 1 or Level 2 covered institution would not be permitted 
to increase a senior executive or significant risk-taker's unvested 
deferred incentive-based compensation.\178\ In other words, any 
deferred incentive-based compensation, whether it was awarded as 
qualifying incentive-based compensation or under a long-term incentive 
plan, would be permitted to vest in an amount equal to or less than the 
amount awarded, but would not be permitted to increase during the 
deferral period.\179\ Deferred incentive-based compensation may be 
decreased, for example, under a forfeiture and downward adjustment 
review as would be required under section __.7(b) of the proposed rule, 
discussed below. It may also be adjusted downward as a result of 
performance that falls short of agreed upon performance measure 
targets.
---------------------------------------------------------------------------

    \178\ This requirement is distinct from the prohibition in 
section 8(b) of the proposed rule, discussed below.
    \179\ Accelerated vesting would be permitted in limited 
circumstances under sections __.7(a)(1)(iii)(B) and 
__.7(a)(2)(iii)(B), as described above.
---------------------------------------------------------------------------

    As discussed in section 8(b), under some incentive-based 
compensation plans, covered persons can be awarded amounts in excess of 
their target amounts if the covered institution or covered person's 
performance exceed performance targets. As explained in the discussion 
on section 8(b), this type of upside leverage in incentive-based 
compensation plans may encourage covered persons to take inappropriate 
risks. Therefore, the proposed rule would limit maximum payouts to 
between 125 and 150 percent of the pre-set target. In a similar vein, 
the Agencies are concerned that allowing Level 1 and Level 2 covered 
institutions to provide for additional increases in amounts that are 
awarded but deferred may encourage senior executive officers and 
significant risk-takers to take more risk during the deferral period 
and thus may not balance risk-taking incentives. This concern is 
especially acute when covered institutions require covered persons to 
meet more aggressive goals than those established at the beginning of 
the performance period in order to ``re-earn'' already awarded, but 
deferred incentive-based compensation.
    Although increases in the amount awarded, as described above, would 
be prohibited by the proposed rule, increases in the value of deferred 
incentive-based compensation due solely to a change in share value, a 
change in interest rates, or the payment of reasonable interest or a 
reasonable rate of return according to terms set out at the award date 
would not be considered increases in the amount awarded for purposes of 
this restriction. Thus, a Level 1 or Level 2 covered institution would 
be permitted to award incentive-based compensation to a senior 
executive officer or significant risk-taker in the form of an equity or 
debt instrument, and, if that instrument increased in market value or 
included a provision to pay a reasonable rate of interest or other 
return that was set at the time of the award, the vesting of the full 
amount of that instrument would not be in violation of the proposed 
rule.
    For an example of how these requirements would work in practice, 
please see Appendix A of this SUPPLEMENTARY INFORMATION section.
    7.12. The Agencies invite comment on the requirement in section 
__.7(a)(3).

Sec.  __.7(a)(4) Composition of Deferred Qualifying Incentive-Based 
Compensation and Deferred Long-Term Incentive Plan Compensation for 
Level 1 and Level 2 Covered Institutions

    Section __.7(a)(4) of the proposed rule would require that deferred 
qualifying incentive-based compensation or deferred incentive-based 
compensation awarded under a long-term incentive plan of a senior 
executive officer or significant risk-taker at a Level 1 or Level 2 
covered institution meet certain composition requirements.
Cash and Equity-Like Instruments
    Covered institutions award incentive-based compensation in a number 
of forms, including cash-based awards, equity-like instruments, and in 
a smaller number of cases, incentive-based compensation in the form of 
debt or debt-like instruments such as deferred cash. First, the 
proposed rule would require that, at Level 1 and Level 2 covered 
institutions \180\ that issue equity

[[Page 37726]]

or are the affiliates of covered institutions that issue equity, 
deferred incentive-based compensation for senior executive officers and 
significant risk-takers include substantial portions of both deferred 
cash and equity-like instruments throughout the deferral period. The 
Agencies recognize that the form of incentive-based compensation that a 
senior executive officer or significant risk-taker receives can have an 
impact on the incentives provided and thus their behavior. In 
particular, having incentive-based compensation in the form of equity-
like instruments can align the interests of the senior executive 
officers and significant risk-takers with the interests of the covered 
institution's shareholders. Thus, the proposed rule would require that 
a senior executive officer's or significant risk-taker's deferred 
incentive-based compensation include a substantial portion of equity-
like instruments.
---------------------------------------------------------------------------

    \180\ In the cases of the Board, FDIC and OCC, this requirement 
would not apply to a Level 1 and Level 2 covered institution that 
does not issue equity itself and is not an affiliate of an 
institution that issues equity. Credit unions and certain mutual 
savings associations, mutual savings banks, and mutual holding 
companies do not issue equity and do not have a parent that issues 
equity. For those institutions, imposing this requirement would have 
little benefit, as no equity-like instruments would be based off of 
the equity of the covered institution or one of its parents. In the 
case of FHFA, this requirement would not apply to a Level 1 or Level 
2 covered institution that does not issue equity or is not permitted 
by FHFA to use equity-like instruments as compensation for senior 
executive officers and significant risk-takers.
---------------------------------------------------------------------------

    Similarly, having incentive-based compensation in the form of cash 
can align the interests of the senior executive officers and 
significant risk-takers with the interests of other stakeholders in the 
covered institution.\181\ Thus, the proposed rule would require that a 
senior executive officer's or significant risk-taker's deferred 
incentive-based compensation include a substantial portion of cash.
---------------------------------------------------------------------------

    \181\ Generally, in the case of resolution or bankruptcy, 
deferred incentive-based compensation in the form of cash would be 
treated similarly to other unsecured debt.
---------------------------------------------------------------------------

    The value of equity-like instruments received by a covered person 
increases or decreases in value based on the value of the equity of the 
covered institution, which provides an implicit method of adjusting the 
underlying value of compensation as the share price of the covered 
institution changes as a result of better or worse operational 
performance. Deferred cash may increase in value over time pursuant to 
an interest rate, but its value generally does not vary based on the 
performance of the covered institution. These two forms of incentive-
based compensation present a covered person with different incentives 
for performance, just as a covered institution itself faces different 
incentives when issuing debt or equity-like instruments.\182\
---------------------------------------------------------------------------

    \182\ Jensen and Meckling (1976) were the first to point out 
that the structure of compensation should reflect all of the 
stakeholders in the firm--both equity and debt holders, an idea 
further explored by Edmans and Liu (2013). Faulkender et al. (2012) 
argue that a compensation program that relies too heavily on stock-
based compensation can lead to excessive risk taking, manipulation, 
and distract from long-term value creation. Empirical research has 
found that equity-based pay increases risk at financial firms 
Balanchandarn et al. 2010). See Jensen and Metcking, ``Theory of the 
Firm: Managerial Behavior, Agency Costs, and Ownership Structure,'' 
3 Journal of Financial Economics 305 (July 1, 1976); Edmans and Liu, 
``Inside Debt,'' 15 Review of Finance 75 (June 29, 2011); 
Faulkender, Kadyrzhanova, Prabhala, and Senbet, ``Executive 
Compensation: An Overview of Research on Corporate Practices and 
Proposed Reforms,'' 22 Journal of Applied Corporate Finance 107 
(2010); and Balachandran, Kogut, and Harnal, ``The Probability of 
Default, Excess Risk and Executive Compensation: A Study of 
Financial Service Firms from 1995 to 2008,'' working paper (June 
2010), available at http://www.insead.edu/facultyresearch/areas/accounting/events/documents/excess_risk_bank_revisedjune21bk.pdf.
---------------------------------------------------------------------------

    For purposes of this proposed rule, the Agencies consider 
incentive-based compensation paid in equity-like instruments to include 
any form of payment in which the final value of the award or payment is 
linked to the price of the covered institution's equity, even if such 
compensation settles in the form of cash. Deferred cash can be 
structured to share many attributes of a debt instrument. For instance, 
while equity-like instruments have almost unlimited upside (as the 
value of the covered institution's shares increase), deferred cash that 
is structured to resemble a debt instrument can be structured so as to 
offer limited upside and can be designed with other features that align 
more closely with the interests of the covered institution's 
debtholders than its shareholders.\183\
---------------------------------------------------------------------------

    \183\ There has been a recent surge in research on the use of 
compensation that has a payoff structure similar to debt, or 
``inside debt.'' See, e.g., Wei and Yermack, ``Investor Reactions to 
CEOs Inside Debt Incentives,'' 24 Review of Financial Studies 3813 
(2011) (finding that bond prices rise, equity prices fall, and the 
volatility of both bond and stock prices fall for firms where the 
CEO has sizable inside debt and arguing the results indicate that 
firms with higher inside debt have lower risk; Cassell, Huang, 
Sanchez, and Stuart, ``Seeking Safety: The Relation between CEO 
Inside Debt Holding and the Riskiness of Firm Investment and 
Financial Policies,'' 103 Journal of Financial Economics 518 (2012) 
(finding higher inside debt is associated with lower volatility of 
future firm stock returns, research and development expenditures, 
and financial leverage, and more diversification and higher asset 
liquidity and empirical research finding that debt holders recognize 
the benefits of firms including debt-like components in their 
compensation structure); Anantharaman, Divya, Fang, and Gong, 
``Inside Debt and the Design of Corporate Debt Contracts,'' 60 
Management Science 1260 (2013) (finding that higher inside debt is 
associated with a lower cost of debt and fewer debt covenants); 
Bennett, Guntay and Unal, ``Inside Debt and Bank Default Risk and 
Performance During the Crisis,'' FDIC Center for Financial Research 
Working Paper No. 2012-3 (finding that banks that had higher inside 
debt before the recent financial crisis had lower default risk and 
higher performance during the crisis and that banks with higher 
inside debt had supervisory ratings that indicate that they had 
stronger capital positions, better management, stronger earnings, 
and being in a better position to withstand market shocks in the 
future); Srivastav, Abhishek, Armitage, and Hagendorff, ``CEO Inside 
Debt Holdings and Risk-shifting: Evidence from Bank Payout 
Policies,'' 47 Journal of Banking & Finance 41 (2014) (finding that 
banks with higher inside debt holdings have a more conservative 
dividend payout policy); Chen, Dou, and Wang, ``Executive Inside 
Debt Holdings and Creditors' Demand for Pricing and Non-Pricing 
Protections,'' working paper (2010) (finding that higher inside debt 
is associated with lower interest rates and less restrictive debt 
covenants and that in empirical research, specifically on banks, 
similar patterns emerge). In addition, the Squam Lake Group has done 
significant work on the use of debt based structures. See, e.g., 
Squam Lake Group, ``Aligning Incentives at Systemically Important 
Financial Institutions'' (2013) available at http://www.squamlakegroup.org/Squam%20Lake%20Bonus%20Bonds%20Memo%20Mar%2019%202013.pdf. In their 
paper ``Enhancing Financial Stability in the Financial Services 
Industry: Contribution of Deferred Cash Compensation,'' forthcoming 
in the Federal Reserve Bank of New York's Economic Policy Review 
(available at https://www.newyorkfed.org/research/epr/index.html), 
Hamid Mehran and Joseph Tracy highlight three channels through which 
deferred cash compensation can help mitigate risk: Promoting 
conservatism, inducing internal monitoring, and creating a liquidity 
buffer.
---------------------------------------------------------------------------

    Where possible, it is important for the incentive-based 
compensation of senior executive officers and significant risk-takers 
at Level 1 and Level 2 covered institutions to have some degree of 
balance between the amounts of deferred cash and equity-like 
instruments received. With the exception of the limitation of use of 
options discussed below, the Agencies propose to provide covered 
institutions with flexibility in meeting the general balancing 
requirement under section __.7(a)(4)(i) and thus have not proposed 
specific percentages of deferred incentive-based compensation that must 
be paid in each form.
    Similar to the rest of section __.7, the requirement in section 
__.7(a)(4)(i) would apply to deferred incentive-based compensation of 
senior executive officers and significant risk-takers of Level 1 and 
Level 2 covered institutions. As discussed above, these covered persons 
are the ones most likely to have a material impact on the financial 
health and risk-taking of the covered institution. Importantly for this 
requirement, these covered persons are also the most likely to be able 
to influence the value of the covered institution's equity and debt.
    7.13. The Agencies invite comment on the composition requirement 
set out in section __.7(a)(4)(i) of the proposed rule.

[[Page 37727]]

    7.14. In order to allow Level 1 and Level 2 covered institutions 
sufficient flexibility in designing their incentive-based compensation 
arrangements, the Agencies are not proposing a specific definition of 
``substantial'' for the purposes of this section. Should the Agencies 
more precisely define the term ``substantial'' (for example, one-third 
or 40 percent) and if so, should the definition vary among covered 
institutions and why? Should the term ``substantial'' be interpreted 
differently for different types of senior executive officers or 
significant risk-takers and why? What other considerations should the 
Agencies factor into level of deferred cash and deferred equity 
required? Are there particular tax or accounting implications attached 
to use of particular forms of incentive-based compensation, such as 
those related to debt or equity?
    7.15. The Agencies invite comment on whether the use of certain 
forms of incentive-based compensation in addition to, or as a 
replacement for, deferred cash or deferred equity-like instruments 
would strengthen the alignment between incentive-based compensation and 
prudent risk-taking.
    7.16. The Agencies invite commenters' views on whether the proposed 
rule should include a requirement that a certain portion of incentive-
based compensation be structured with debt-like attributes. Do debt 
instruments (as opposed to equity-like instruments or deferred cash) 
meaningfully influence the behavior of senior executive officers and 
significant risk-takers? If so, how? How could the specific attributes 
of deferred cash be structured, if at all, to limit the amount of 
interest that can be paid? How should such an interest rate be 
determined, and how should such instruments be priced? Which attributes 
would most closely align use of a debt-like instrument with the 
interest of debt holders and promote risk-taking that is not likely to 
lead to material financial loss?
Options
    Under section __.7(a)(4)(ii), for senior executive officers and 
significant risk-takers at Level 1 and Level 2 covered institutions 
that receive incentive-based compensation in the form of options, the 
total amount of such options that may be used to meet the minimum 
deferral amount requirements is limited to, no more than 15 percent of 
the amount of total incentive-based compensation awarded for a given 
performance period. A Level 1 or Level 2 covered institution would be 
permitted to award incentive-based compensation to senior executive 
officers and significant risk-takers in the form of options in excess 
of this limitation, and could defer such compensation, but the 
incentive-based compensation in the form of options in excess of the 15 
percent limit would not be counted towards meeting the minimum deferral 
requirements for senior executive officers and significant risk-takers 
at these covered institutions.
    For example, a Level 1 covered institution might award a 
significant risk-taker $100,000 in incentive-based compensation at the 
end of a performance period: $80,000 in qualifying incentive-based 
compensation, of which $25,000 is in options, and $20,000 under a long-
term incentive plan, all of which is delivered in cash. The Level 1 
covered institution would be required to defer at least $40,000 of the 
qualifying incentive-based compensation and at least $10,000 of the 
amount awarded under the long-term incentive plan. Under the draft 
proposed rule, the amount that could be composed of options and count 
toward the overall deferral requirement would be limited to 15 percent 
of the total amount of incentive-based compensation awarded. In this 
example, the Level 1 covered institution could count $15,000 in options 
(15 percent of $100,000) toward the requirement to defer $40,000 of 
qualifying incentive-based compensation. For an example of how these 
requirements would work in the context of a more complete incentive-
based compensation arrangement, please see Appendix A of this preamble.
    This requirement would thus limit the total amount of incentive-
based compensation in the form of options that could satisfy the 
minimum deferral amounts in sections __.7(a)(1)(i) and __.7(a)(1)(ii). 
Any incentive-based compensation awarded in the form of options would, 
however, be required to be included in calculating the total amount of 
incentive-based compensation awarded in a given performance period for 
purposes of calculating the minimum deferral amounts at Level 1 and 
Level 2 covered institutions as laid out in sections __.7(a)(1)(i) and 
__.7(a)(2)(ii).
    Options can be a significant and important part of incentive-based 
compensation arrangements at many covered institutions. The Agencies 
are concerned, however, that overreliance on options as a form of 
incentive-based compensation could have negative effects on the 
financial health of a covered institution due to options' emphasis on 
upside gains and possible lack of responsiveness to downside 
risks.\184\
---------------------------------------------------------------------------

    \184\ In theory, since the payoffs from holding stock options 
are positively related to volatility of stock returns, options 
create incentives for executives to increase the volatility of share 
prices by engaging in riskier activities. See, e.g., Guay, W.R., 
``The Sensitivity of CEO Weather to Equity Risk: An Analysis of the 
Magnitude and Determinants,'' 53 Journal of Financial Economics 43 
(1999); Cohen, Hall, and Viceira, ``Do Executive Stock Options 
Encourage Risk Taking?'' working paper (2000) available at http://www.people.hbs.edu/lviceira/cohallvic3.pdf; Rajgopal and Shvelin, 
``Empirical Evidence on the Relation between Stock Option 
Compensation and Risk-Taking,'' 33 Journal of Accounting and 
Economics 145 (2002); Coles, Daniel, and Naveen, ``Managerial 
Incentives and Risk-Taking,'' 79 Journal of Financial Economics 431 
(2006); Chen, Steiner, and Whyte, ``Does Stock Option-Based 
Executive Compensation Induce Risk-Taking? An Analysis of the 
Banking Industry,'' 30 Journal of Banking & Finance 916 (2006); 
Mehran, Hamid and Rosenberg, ``The Effect of Employee Stock Options 
on Bank Investment Choice, Borrowing and Capital,'' Federal Reserve 
Bank of New York Staff Reports No. 305 (2007) available at https://www.newyorkfed.org/medialibrary/media/research/staff_reports/sr305.pdf.
    Beyond the typical measures of risk, the academic literature has 
found a relation between executive stock option holdings and risky 
behavior. See, e.g., Denis, Hanouna, and Sarin, ``Is There a Dark 
Side to Incentive Compensation?'' 12 Journal of Corporate Finance 
467 (2006) (finding that there is a significant positive association 
between the likelihood of securities fraud allegations and the 
executive stock option incentives); Bergstresser and Phillippon, 
``CEO Incentives and Earnings Management,'' 80 Journal of Financial 
Economics 511 (2006) (finding that the use of discretionary accruals 
to manipulate reported earnings was more pronounced at firms where 
CEO's compensation was more closely tied to stock and option 
holdings).
---------------------------------------------------------------------------

    The risk dynamic for senior executive officers and significant 
risk-takers changes when options are awarded because options offer 
asymmetric payoffs for stock price performance. Options may generate 
very high payments to covered persons when the market price of a 
covered institution's shares rises, representing a leveraged return 
relative to shareholders. Payment of incentive-based compensation in 
the form of options may therefore increase the incentives under some 
market conditions for covered persons to take inappropriate risks in 
order to increase the covered institution's short-term share price, 
possibly without giving appropriate weight to long-term risks.
    Moreover, unlike restricted stock, options are limited in how much 
they decrease in value when the covered institution's shares decrease 
in value.\185\ Thus, options may not be an effective tool for causing a 
covered person to adjust his or her behavior to manage downside risk. 
For senior executive officers and significant risk-takers, whose 
activities can materially impact the firm's stock price, incentive-
based

[[Page 37728]]

compensation based on options may therefore create greater incentive to 
take inappropriate risk or provide inadequate disincentive to manage 
risk. For these reasons, the Agencies are proposing to limit to 15 
percent the amount permitted to be used in meeting the minimum deferral 
requirements.
---------------------------------------------------------------------------

    \185\ This would be the case if the current market price for a 
share is less than or equal to the option's strike price (i.e., the 
option is not ``in the money'').
---------------------------------------------------------------------------

    In proposing to limit, but not prohibit, the use of options to 
fulfill the proposed rule's deferral requirements, the Agencies have 
sought to conservatively apply better practice while still allowing for 
some flexibility in the design and operation of incentive-based 
compensation arrangements. The Agencies note that supervisory 
experience at large banking organizations and analysis of compensation 
disclosures, as well as the views of some commenters to the 2011 
Proposed Rule, indicate that many institutions have recognized the 
risks of options as an incentive and have reduced their use of options 
in recent years.
    The proposed rule's 15 percent limit on options is consistent with 
current industry practice, which is moving away from its historical 
reliance on options as part of incentive-based compensation. Since the 
financial crisis that began in 2007, institutions on their own 
initiative and those working with the Board have decreased the use of 
options in incentive-based compensation arrangements generally such 
that for most organizations options constitute no more than 15 percent 
of an institution's total incentive-based compensation. Restricted 
stock unit awards have now emerged as the most common form of equity 
compensation and are more prevalent than stock options at all employee 
levels.\186\ Further, a sample of publicly available disclosures from 
large covered institutions shows minimal usage of stock options among 
CEOs and other named executive officers; out of a sample of 14 covered 
institutions reviewed by the Agencies, only two covered institutions 
awarded stock options as part of their incentive-based compensation in 
2015. Only one of those two covered institutions awarded options in 
excess of 15 percent of total compensation, and the excess was small. 
Thus, the proposed rule's limit on options has been set at a level that 
would, in the Agencies' views, help mitigate concerns about the use of 
options in incentive-based compensation while still allowing 
flexibility for covered institutions to use options in a manner that is 
consistent with the better practices that have developed following the 
recent financial crisis.\187\
---------------------------------------------------------------------------

    \186\ Bachelder, Joseph E., ``What Has Happened To Stock 
Options,'' New York Law Journal (September 19, 2014).
    \187\ Rajgopal and Shvelin, ``Empirical Evidence on the Relation 
between Stock Option Compensation and Risk-Taking,'' 33 Journal of 
Accounting and Economics 145 (2002); Bettis, Bizjak, and Lemmon, 
``Exercise Behavior, Valuation, and the Incentive Effects of 
Employee Stock Options,'' 76 Journal of Financial Economics 445; ISS 
Compensation FAQs.
---------------------------------------------------------------------------

    7.17. The Agencies invite comment on the restrictions on the use of 
options in incentive-based compensation in the proposed rule. Should 
the percent limit be higher or lower and if so, why? Should options be 
permitted to be used to meet the deferral requirements of the rule? Why 
or why not? Does the use of options by covered institutions create, 
reduce, or have no effect on the institution's risk of material 
financial loss?
    7.18. Does the proposed 15 percent limit appropriately balance the 
benefits of using options (such as aligning the recipient's interests 
with that of shareholders) and drawbacks of using options (such as 
their emphasis on upside gains)? Why or why not? Is the proposed 15 
percent limit the appropriate limit, or should it be higher or lower? 
If it should be higher or lower, what should the limit be, and why?
    7.19. Are there alternative means of addressing the concerns raised 
by options as a form of incentive-based compensation other than those 
proposed?

Sec.  __.7(b) Forfeiture and Downward Adjustment

    Section __.7(b) of the proposed rule would require Level 1 and 
Level 2 covered institutions to place incentive-based compensation of 
senior executive officers and significant risk-takers at risk of 
forfeiture and downward adjustment and to subject incentive-based 
compensation to a forfeiture and downward adjustment review under a 
defined set of circumstances. As described below, a forfeiture and 
downward adjustment review would be required to identify senior 
executive officers or significant risk-takers responsible for the 
events or circumstances triggering the review. It would also be 
required to consider certain factors when determining the amount or 
portion of a senior executive officer's or significant risk-taker's 
incentive-based compensation that should be forfeited or adjusted 
downward.
    In general, the forfeiture and downward adjustment review 
requirements in section __.7(b) would require a Level 1 or Level 2 
covered institution to consider reducing some or all of a senior 
executive officer's or significant risk-taker's incentive-based 
compensation when the covered institution becomes aware of 
inappropriate risk-taking or other aspects of behavior that could lead 
to material financial loss. The amount of incentive-based compensation 
that would be reduced would depend upon the severity of the event, the 
impact of the event on the covered institution, and the actions of the 
senior executive officer or significant risk-taker in the event. The 
covered institution could accomplish this reduction of incentive-based 
compensation by reducing the amount of unvested deferred incentive-
based compensation (forfeiture), by reducing the amount of incentive-
based compensation not yet awarded for a performance period that has 
begun (downward adjustment), or through a combination of both 
forfeiture and downward adjustment. The Agencies have found that the 
possibility of a reduction in incentive-based compensation in the 
circumstances identified in section __.7(b)(2) of the rule is needed in 
order to properly align financial reward with risk-taking by senior 
executive officers and significant risk-takers at Level 1 and Level 2 
covered institutions.
    The possibility of forfeiture and downward adjustment under the 
proposed rule would play an important role not only in better aligning 
incentive-based compensation payouts with long-run risk outcomes at the 
covered institution but also in reducing incentives for senior 
executive officers and significant risk-takers to take inappropriate 
risk that could lead to material financial loss at the covered 
institution. The proposed rule would also require covered institutions, 
through policies and procedures,\188\ to formalize the governance and 
review processes surrounding such decision-making, and to document the 
decisions made.
---------------------------------------------------------------------------

    \188\ See sections __.11(b) and __.11(c).
---------------------------------------------------------------------------

    While forfeiture and downward adjustment reviews would be required 
components of incentive-based compensation arrangements for senior 
executive officers and significant risk-takers at Level 1 and Level 2 
covered institutions under the proposed rule, and are one way for 
covered institutions to take into account information about performance 
that becomes known over time, such reviews would not alone be 
sufficient to appropriately balance risk and reward, as would be 
required under section __.4(c)(1). Incentive-based compensation 
arrangements for those

[[Page 37729]]

covered persons would also be required to comply with the specific 
requirements of sections __.4(d), __.7(a), __.7(c) and __.8. As 
discussed above, to achieve balance between risk and reward, covered 
institutions should examine incentive-based compensation arrangements 
as a whole, and consider including provisions for risk adjustments 
before the award is made, and for adjustments resulting from forfeiture 
and downward adjustment review during the deferral period.

Sec.  __.7(b)(1) Compensation at Risk

    Under the proposed rule, a Level 1 or Level 2 covered institution 
would be required to place at risk of forfeiture 100 percent of a 
senior executive officer's or significant risk-taker's deferred and 
unvested incentive-based compensation, including unvested deferred 
amounts awarded under long-term incentive plans. Additionally, a Level 
1 or Level 2 covered institution would be required to place at risk of 
downward adjustment all of a senior executive officer's or significant 
risk-taker's incentive-based compensation that has not yet been 
awarded, but that could be awarded for a performance period that is 
underway and not yet completed.
    Forfeiture and downward adjustment give covered institutions an 
appropriate set of tools through which consequences may be imposed on 
individual risk-takers when inappropriate risk-taking or misconduct, 
such as the events identified in section __.7(b)(2), occur or are 
identified. They also help ensure that a sufficient amount of 
compensation is at risk. Certain risk management failures and 
misconduct can take years to manifest, and forfeiture and downward 
adjustment reviews provide covered institutions an opportunity to 
adjust the ultimate amount of incentive-based compensation that vests 
based on information about risk-taking or misconduct that comes to 
light after the performance period. A senior executive officer or 
significant risk-taker should not be rewarded for inappropriate risk-
taking or misconduct, regardless of when the covered institution learns 
of it.
    Some evidence of inappropriate risk taking, risk management 
failures and misconduct may not be immediately apparent to the covered 
institution. To provide a strong disincentive for senior executive 
officers and significant risk-takers to engage in such conduct, which 
may lead to material financial loss to the covered institution, the 
Agencies are proposing to require that all unvested deferred incentive-
based compensation and all incentive-based compensation eligible to be 
awarded for the performance period in which the covered institution 
becomes aware of the conduct be available for forfeiture and downward 
adjustment under the forfeiture and downward adjustment review. A 
covered institution would be required to consider all incentive-based 
compensation available, in the form of both unvested deferred 
incentive-based compensation and yet-to-be awarded incentive-based 
compensation, when considering forfeiture or downward adjustments, even 
if the incentive-based compensation does not specifically relate to the 
performance in the period in which the relevant event occurred.
    For example, a significant risk-taker of a Level 1 covered 
institution might engage in misconduct in June 2025, but the Level 1 
covered institution might not become aware of the misconduct until 
September 2028. The Level 1 covered institution would be required to 
consider downward adjustment of any amounts available under any of the 
significant risk-taker's incentive-based compensation plans with 
performance periods that are still in progress as of September 2028 
(for example, an annual plan with a performance period that runs from 
January 1, 2028, to December 31, 2028, or a long-term incentive plan 
with a performance period that runs from January 1, 2027, to December 
31, 2030). The Level 1 covered institution would also be required to 
consider forfeiture of any amounts that are deferred, but not yet 
vested, as of September 2028 (for example, amounts that were awarded 
for a performance period that ran from January 1, 2026, to December 31, 
2026, and that have been deferred and do not vest until December 31, 
2030). For an additional example of how these requirements would work 
in practice, please see Appendix A of this Supplementary Information 
section.

Sec.  __.7(b)(2) Events Triggering Forfeiture and Downward Adjustment 
Review

    Section __.7(b) of the proposed rule would require a Level 1 or 
Level 2 covered institution to conduct a forfeiture and downward 
adjustment review based on certain identified adverse outcomes.
    Under section __.7(b), events \189\ that would be required to 
trigger a forfeiture and downward adjustment review include: (1) Poor 
financial performance attributable to a significant deviation from the 
risk parameters set forth in the covered institution's policies and 
procedures; (2) inappropriate risk-taking, regardless of the impact on 
financial performance; (3) material risk management or control 
failures; and (4) non-compliance with statutory, regulatory, or 
supervisory standards that results in: Enforcement or legal action 
against the covered institution brought by a Federal or state regulator 
or agency; or a requirement that the covered institution report a 
restatement of a financial statement to correct a material error. 
Covered institutions would be permitted to define additional triggers 
based on conduct or poor performance. Generally, in the Agencies' 
supervisory experience as earlier described, the triggers are 
consistent with current practice at the largest financial institutions, 
although many covered institutions have triggers that are more granular 
in nature than those proposed and cover a wider set of adverse 
outcomes. The proposed enumerated adverse outcomes are a set of minimum 
standards.
---------------------------------------------------------------------------

    \189\ The underlying, or contractual, forfeiture language used 
by institutions need not be identical to the triggers enumerated in 
this section, provided the covered institution's triggers capture 
the full set of outcomes outlined in section 7(b)(2) of the rule. 
For example, a trigger at a covered institution that read ``if an 
employee improperly or with gross negligence fails to identify, 
raise, or assess, in a timely manner and as reasonably expected, 
risks and/or concerns with respect to risks material to the 
institution or its business activities,'' would be considered 
consistent with the minimum parameters set forth in the trigger 
identified in section 7(b)(2)(ii) of the rule.
---------------------------------------------------------------------------

    As discussed later in this SUPPLEMENTARY INFORMATION section, 
covered institutions would be required to provide for the independent 
monitoring of all events related to forfeiture and downward 
adjustment.\190\ When such monitoring, or other risk surveillance 
activity, reveals the occurrence of events triggering forfeiture and 
downward adjustment reviews, Level 1 and Level 2 covered institutions 
would be required to conduct those reviews in accordance with section 
__.7(b). Covered institutions may choose to coordinate the monitoring 
for triggering events under section __.9(c)(2) and the forfeiture and 
downward adjustment reviews with broader risk surveillance activities. 
Such coordinated reviews could take place on a schedule identified by 
the covered institution. Schedules may vary among covered institutions, 
but they should occur often enough to appropriately monitor risks and 
events related to forfeiture and downward adjustment. Larger covered 
institutions with more complex operations are likely to need to conduct 
more frequent

[[Page 37730]]

reviews to ensure effective risk management.
---------------------------------------------------------------------------

    \190\ See section __.9(c)(2).
---------------------------------------------------------------------------

    Poor financial performance can indicate that inappropriate risk-
taking has occurred at a covered institution. The Agencies recognize 
that not all inappropriate risk-taking does, in fact, lead to poor 
financial performance, but given the risks that are posed to the 
covered institutions by poorly designed incentive-based compensation 
programs and the statutory mandate of section 956, it is appropriate to 
prohibit incentive-based compensation arrangements that reward such 
inappropriate risk-taking. Therefore, if evidence of past inappropriate 
risk-taking becomes known, the proposed rule would require a Level 1 or 
Level 2 covered institution to perform a forfeiture and downward 
adjustment review in order to assess whether the relevant senior 
executive officer's or significant risk-taker's incentive-based 
compensation should be affected by the inappropriate risk-taking.
    Similarly, material risk management or control failures may allow 
for inappropriate risk-taking that may lead to material financial loss 
at a covered institution. Because the role of senior executive officers 
and significant risk-takers, including those in risk management and 
other control functions whose role is to identify, measure, monitor, 
and control risk, the material failure by covered persons to properly 
perform their responsibilities can be especially likely to put an 
institution at risk. Thus, if evidence of past material risk management 
or control failures becomes known, the proposed rule would require a 
Level 1 or Level 2 covered institution to perform a forfeiture and 
downward adjustment review, to assess whether a senior executive 
officer or significant risk-taker's incentive-based compensation should 
be affected by the risk management or control failure. Examples of risk 
management or control failures would include failing to properly 
document or report a transaction or failing to properly identify and 
control the risks that are associated with a transaction. In each case, 
the risk management or control failure, if material, could allow for 
inappropriate risk-taking at a covered institution that could lead to 
material financial loss.
    Finally, a covered institution's non-compliance with statutory, 
regulatory, or supervisory standards may also reflect inappropriate 
risk-taking that may lead to material financial loss at a covered 
institution. The proposed rule would require a forfeiture and downward 
adjustment review whenever any such non-compliance (1) results in an 
enforcement or legal action against the covered institution brought by 
a Federal or state regulator or agency; or (2) requires the covered 
institution to restate a financial statement to correct a material 
error. The Federal Banking Agencies have found that it is appropriate 
for a covered institution to conduct a forfeiture and downward 
adjustment review under these circumstances because in many cases a 
statutory, regulatory, or supervisory standard may have been put in 
place in order to prevent a covered person from taking an inappropriate 
risk. In addition, non-compliance with a statute, regulation, or 
supervisory standard may also give rise to inappropriate compliance 
risk for a covered institution. A forfeiture and downward adjustment 
review would allow the institution to assess whether this type of non-
compliance should affect a senior executive officer or significant 
risk-taker's incentive-based compensation.

Sec.  __.7(b)(3) Senior Executive Officers and Significant Risk-Takers 
Affected by Forfeiture and Downward Adjustment

    A forfeiture and downward adjustment review would be required to 
consider forfeiture and downward adjustment of incentive-based 
compensation for a senior executive officer and significant risk-taker 
with direct responsibility or responsibility due to the senior 
executive officer or significant risk-taker's role or position in the 
covered institution's organizational structure, for the events that 
would trigger a forfeiture and downward adjustment review as described 
in section __.7(b)(2). Covered institutions should consider not only 
senior executive officers or significant risk-takers who are directly 
responsible for an event that triggers a forfeiture or downward 
adjustment review, but also those senior executive officers or 
significant risk-takers whose roles and responsibilities include areas 
where failures or poor performance contributed to, or failed to 
prevent, a triggering event. This requirement would discourage senior 
executive officers and significant risk-takers who can influence 
outcomes from failing to report or prevent inappropriate risk. A 
covered institution conducting a forfeiture and downward adjustment 
review may also consider forfeiture for other covered persons at its 
discretion.

Sec.  __.7(b)(4) Determining Forfeiture and Downward Adjustment Amounts

    The proposed rule sets out factors that Level 1 and Level 2 covered 
institutions must consider, at a minimum, when making a determination 
to reduce incentive-based compensation as a result of a forfeiture or 
downward adjustment review. A Level 1 or Level 2 covered institution 
would be responsible for determining how much of a reduction in 
incentive-based compensation is warranted, consistent with the policies 
and procedures it establishes under Sec.  __.11(b), and should be able 
to support its decisions that such an adjustment was appropriate if 
requested by its appropriate Federal regulator. In reducing the amount 
of incentive-based compensation, covered institutions may reduce the 
dollar amount of deferred cash or cash to be awarded, may lower the 
amount of equity-like instruments that have been deferred or were 
eligible to be awarded, or some combination thereof. A reduction in the 
value of equity-like instruments due to market fluctuations would not 
be considered a reduction for purposes of this review.
    The proposed minimum factors that would be required to be 
considered when determining the amount of incentive-based compensation 
to be reduced are: (1) The intent of the senior executive officer or 
significant risk-taker to operate outside the risk governance framework 
approved by the covered institution's board of directors or to depart 
from the covered institution's policies and procedures; (2) the senior 
executive officer's or significant risk-taker's level of participation 
in, awareness of, and responsibility for, the events triggering the 
review; (3) any actions the senior executive officer or significant 
risk-taker took or could have taken to prevent the events triggering 
the review; (4) the financial and reputational impact of the events 
\191\ triggering the review as set forth in section __.7(b)(2) on the 
covered institution, the line or sub-line of business, and individuals 
involved, as applicable, including the magnitude of any financial loss 
and the cost of known or potential subsequent fines, settlements, and 
litigation; (5) the causes of the events triggering the review, 
including any decision-making

[[Page 37731]]

by other individuals; and (6) any other relevant information, including 
past behavior and risk outcomes linked to past behavior attributable to 
the senior executive officer or significant risk-taker.
---------------------------------------------------------------------------

    \191\ Reputational impact or harm related to the actions of 
covered individuals refers to a potential weakening of confidence in 
an institution as evidenced by negative reactions from customers, 
shareholders, bondholders and other creditors, consumer and 
community groups, the press, or the general public. Reputational 
impact is a factor currently considered by some institutions in 
their existing forfeiture policies. See, e.g., Wells Fargo & Company 
2016 Proxy Statement, page 47, available at https://www08.wellsfargomedia.com/assets/pdf/about/investor-relations/annual-reports/2016-proxy-statement.pdf; and Citigroup 2016 Proxy 
Statement, page 74, available at http://www.citigroup.com/citi/investor/quarterly/2016/ar16cp.pdf?ieNocache=611.
---------------------------------------------------------------------------

    The considerations identified constitute a minimum set of 
parameters that would be utilized for exercising the discretion 
permissible under the proposed rule while still holding senior 
executive officers and significant risk-takers accountable for 
inappropriate risk-taking and other behavior that could encourage 
inappropriate risk-taking that could lead to risk of material financial 
loss at covered institutions. For example, a covered institution might 
identify a pattern of misconduct stemming from activities begun three 
years before the review that ultimately leads to an enforcement action 
and reputational damage to the covered institution. A review of facts 
and circumstances, including consideration of the minimum review 
parameters set forth in the proposed rule, could reveal that one 
individual knowingly removed transaction identifiers in order to 
facilitate a trade or trades with a counterparty on whom regulators had 
applied Bank Secrecy Act or Anti-Monetary Laundering sanctions. Several 
of the senior executive officer's or significant risk-taker's peers 
might have been aware of this pattern of behavior but did not report it 
to their managers. Under the proposed rule, the individual who 
knowingly removed the identifiers would, in most cases, be subject to a 
greater reduction in incentive-based compensation than those who were 
aware of but not participants in the misconduct. However, those peers 
that were aware of the misconduct, managers supervising the covered 
person directly involved in the misconduct, and control staff who 
should have detected but failed to detect the behavior would be 
considered for a reduction, depending on their role in the 
organization, and assuming the peers are now senior executive officers 
or significant risk-takers.
    The Agencies do not intend for these proposed factors to be 
exhaustive and covered institutions should consider additional factors 
where appropriate. In addition, covered institutions generally should 
impact incentive-based compensation as a result of forfeiture and 
downward adjustment reviews to reflect the severity of the event that 
triggered the review and the level of an individual's involvement. 
Covered institutions should be able to demonstrate to the appropriate 
Federal regulator that the impact on incentive-based compensation was 
appropriate given the particular set of facts and circumstances.
    7.20. The Agencies invite comment on the forfeiture and downward 
adjustment requirements of the proposed rule.
    7.21. Should the rule limit the events that require a Level 1 or 
Level 2 covered institution to consider forfeiture and downward 
adjustment to adverse outcomes that occurred within a certain time 
period? If so, why and what would be an appropriate time period? For 
example, should the events triggering forfeiture and downward 
adjustment reviews be limited to those events that occurred within the 
previous seven years?
    7.22. Should the rule limit forfeiture and downward adjustment 
reviews to reducing only the incentive-based compensation that is 
related to the performance period in which the triggering event(s) 
occurred? Why or why not? Is it appropriate to subject unvested or 
unawarded incentive-based compensation to the risk of forfeiture or 
downward adjustment, respectively, if the incentive-based compensation 
does not specifically relate to the performance in the period in which 
the relevant event occurred or manifested? Why or why not?
    7.23. Should the rule place all unvested deferred incentive-based 
compensation, including amounts voluntarily deferred by Level 1 and 
Level 2 covered institutions or senior executive officers or 
significant risk-takers, at risk of forfeiture? Should only that 
unvested deferred incentive-based compensation that is required to be 
deferred under section __.7(a) be at risk of forfeiture? Why or why 
not?
    7.24. Are the events triggering a review that are identified in 
section __.7(b)(2) comprehensive and appropriate? If not, why not? 
Should the Agencies add ``repeated supervisory actions'' as a 
forfeiture or downward adjustment review trigger and why? Should the 
Agencies add ``final enforcement or legal action'' instead of the 
proposed ``enforcement or legal action'' and why?
    7.25. Is the list of factors that a Level 1 or Level 2 covered 
institution must consider, at a minimum, in determining the amount of 
incentive-based compensation to be forfeited or downward adjusted by a 
covered institution appropriate? If not, why not? Are any of the 
factors proposed unnecessary? Should additional factors be included?
    7.26. Are the proposed parameters for forfeiture and downward 
adjustment review sufficient to provide an appropriate governance 
framework for making forfeiture decisions while still permitting 
adequate discretion for covered institutions to take into account 
specific facts and circumstances when making determinations related to 
a wide variety of possible outcomes? Why or why not?
    7.27. Should the rule include a presumption of some amount of 
forfeiture for particularly severe adverse outcomes and why? If so, 
what should be the amount and what would those outcomes be?
    7.28. What protections should covered institutions employ when 
making forfeiture and downward adjustment determinations?
    7.29. In order to determine when forfeiture and downward adjustment 
should occur, should Level 1 and Level 2 covered institutions be 
required to establish a formal process that both looks for the 
occurrence of trigger events and fulfills the requirements of the 
forfeiture and downward adjustment reviews under the proposed rule? If 
not, why not? Should covered institutions be required as part of the 
forfeiture and downward adjustment review process to establish formal 
review committees including representatives of control functions and a 
specific timetable for such reviews? Should the answer to this question 
depend on the size of the institution considered?

Sec.  __.7(c) Clawback

    As used in the proposed rule, the term ``clawback'' means a 
mechanism by which a covered institution can recover vested incentive-
based compensation from a covered person. The proposed rule would 
require Level 1 and Level 2 covered institutions to include clawback 
provisions in incentive-based compensation arrangements for senior 
executive officers and significant risk-takers that, at a minimum, 
would allow for the recovery of up to 100 percent of vested incentive-
based compensation from a current or former senior executive officer or 
significant risk-taker for seven years following the date on which such 
compensation vests. Under section __.7(c) of the proposed rule, all 
vested incentive-based compensation for senior executive officers and 
significant risk-takers, whether it had been deferred before vesting or 
paid out immediately upon award, would be required to be subject to 
clawback for a period of no less than seven years following the date on 
which such incentive-based compensation vests. Clawback would be 
exercised under an identified set of circumstances. These circumstances 
include situations where a senior executive officer or significant 
risk-taker engaged in: (1) Misconduct that resulted in significant 
financial or

[[Page 37732]]

reputational harm \192\ to the covered institution; (2) fraud; or (3) 
intentional misrepresentation of information used to determine the 
senior executive officer's or significant risk-taker's incentive-based 
compensation.\193\ The clawback provisions would apply to all vested 
incentive-based compensation, whether that incentive-based compensation 
had been deferred or paid out immediately when awarded. If a Level 1 or 
Level 2 covered institution discovers that a senior executive officer 
or significant risk-taker was involved in one of the triggering 
circumstances during a past performance period, the institution would 
potentially be able to recover from that senior executive officer or 
significant risk-taker incentive-based compensation that was awarded 
for that performance period and has already vested. A covered 
institution could require clawback irrespective of whether the senior 
executive officer or significant risk-taker was currently employed by 
the covered institution.
---------------------------------------------------------------------------

    \192\ As described in the above note 191, reputational impact or 
harm of an event related to the actions of covered individuals 
refers to a potential weakening of confidence in an institution as 
evidenced by negative reactions from customers, shareholders, 
bondholders and other creditors, consumer and community groups, the 
press, or the general public.
    \193\ As with other provisions in this proposed rule, the 
clawback requirement would not apply to incentive-based compensation 
plans and arrangements in place at the time the proposed rule is 
final because those plans and arrangements would be grandfathered.
---------------------------------------------------------------------------

    The proposed set of triggering circumstances would constitute a 
minimum set of outcomes for which covered institutions would be 
required to consider recovery of vested incentive-based compensation. 
Covered institutions would retain flexibility to include other 
circumstances or outcomes that would trigger additional use of such 
provisions.
    In addition, while the proposed rule would require the inclusion of 
clawback provisions in incentive-based compensation arrangements, the 
proposed rule would not require that Level 1 or Level 2 covered 
institutions exercise the clawback provision, and the proposed rule 
does not prescribe the process that covered institutions should use to 
recover vested incentive-based compensation. Facts, circumstances, and 
all relevant information should determine whether and to what extent it 
is reasonable for a Level 1 or Level 2 covered institution to seek 
recovery of any or all vested incentive-based compensation.
    The Agencies recognize that clawback provisions may provide another 
effective tool for Level 1 and Level 2 covered institutions to deter 
inappropriate risk-taking because it lengthens the time horizons of 
incentive-based compensation.\194\ The Agencies are proposing that 
vested incentive-based compensation be subject to clawback for up to 
seven years. The Agencies are proposing seven years as the length of 
the review period because it is slightly longer than the length of the 
average business cycle in the United States and is close to the lower 
end of the range of average credit cycles.\195\ Also, the Agencies 
observe that seven years is consistent with some international 
standards.\196\
---------------------------------------------------------------------------

    \194\ See, e.g., Faulkender, Kadyrzhanova, Prabhala, and Senbet, 
``Executive Compensation: An Overview of Research on Corporate 
Practices and Proposed Reforms,'' 22 Journal of Applied Corporate 
Finance 107 (2010) (arguing that clawbacks guard against 
compensating executives for luck rather than long-term performance); 
Babenko, Bennett, Bizjak and Coles, ``Clawback Provisions,'' working 
paper (2015) available at https://wpcarey.asu.edu/sites/default/files/uploads/department-finance/clawbackprovisions.pdf (finding 
that the use of clawback provisions are associated with lower 
institution risk); Chen, Greene, and Owers, ``The Costs and Benefits 
of Clawback Provisions in CEO Compensation,'' 4 Review of Corporate 
Finance Studies 108 (2015) (finding that the use of clawback 
provisions are associated with higher reporting quality).
    \195\ See supra note 154.
    \196\ See, e.g., PRA, ``Policy Statement PS7/14: Clawback'' 
(July 2014), available at http://www.bankofengland.co.uk/pra/Documents/publications/ps/2014/ps714.pdf.
---------------------------------------------------------------------------

    By proposing seven years as the length of the review period, the 
Agencies intend to encourage institutions to fairly compensate covered 
persons and incentivize appropriate risk-taking, while also recognizing 
that recovering amounts that have already been paid is more difficult 
than reducing compensation that has not yet been paid. The Agencies are 
concerned that a clawback period that is too short or one that is too 
long, or even infinite, could result in the covered person ignoring or 
discounting the effect of the clawback period and accordingly, could be 
less effective in balancing risk-taking. Additionally, a very long or 
even infinite clawback period may be difficult to implement.
    While the Agencies did not propose a clawback requirement in the 
2011 Proposed Rule, mandatory clawback provisions are not a new 
concept. Commenters to the 2011 Proposed Rule advocated that the 
Agencies adopt measures to allow shareholders (and others) to recover 
incentive-based compensation already paid to covered persons. As 
discussed above, clawback provisions are now increasingly common at the 
largest financial institutions. The largest (and mostly publicly 
traded) covered institutions are already subject to a number of 
overlapping clawback regimes as a result of statutory 
requirements.\197\ Over the past several years, many financial 
institutions have further refined such mechanisms.\198\ Most often, 
clawbacks allow banking institutions to recoup incentive-based 
compensation in cases of financial restatement, misconduct, or poor 
financial outcomes. A number of covered institutions have gone beyond 
these minimum parameters to include situations where poor risk 
management has led to financial or reputational damage to the 
firm.\199\ The Agencies were cognizant of these developments in 
proposing the clawback provision in section __.7(c).
---------------------------------------------------------------------------

    \197\ See, e.g., section 304 of the Sarbanes-Oxley Act of 2002, 
15 U.S.C. 7243; section 111 of the Emergency Economic Stabilization 
Act of 2008, 12 U.S.C. 5221; section 210(s) of the Dodd-Frank Act, 
12 U.S.C. 5390(s); section 954 of the Dodd-Frank Act, 15 U.S.C. 78j-
4(b).
    \198\ See, e.g., PricewaterhouseCoopers, ``Executive 
Compensation: Clawbacks, 2014 Proxy Disclosure Study'' (January 
2015), available at http://www.pwc.com/us/en/hr-management/publications/assets/pwc-executive-compensation-clawbacks-2014.pdf; 
Compensation Advisory Partners, ``2014 Proxy Season: Changing 
Practices in Executive Compensation: Clawback, Hedging, and Pledging 
Policies'' (December 17, 2014), available at http://www.capartners.com/uploads/news/id204/capartners.com-capflash-issue62.pdf.
    \199\ See, e.g., JPMorgan Chase & Company 2015 Proxy Statement, 
page 56, available at http://files.shareholder.com/downloads/ONE/1425504805x0x820065/4c79f471-36d9-47d4-a0b3-7886b0914c92/JPMC-2015-ProxyStatementl.pdf (where vested compensation is subject to 
clawback if, among other things, ``the employee engaged in conduct 
detrimental to the Firm that causes material financial or 
reputational harm to the Firm'').
---------------------------------------------------------------------------

    The Agencies propose the three triggers referenced above for 
several reasons. First, a number of the specified triggers reflect 
better practice at covered institutions today.\200\ The factors 
triggering clawback are based on existing clawback requirements that 
appear in some covered institutions' incentive-based compensation 
arrangements. Second, while many of the clawback regulatory regimes 
currently in place focus only on accounting restatements or material 
misstatements of financial results, the proposed triggers focus more 
broadly on risk-related outcomes that are more likely to contribute 
meaningfully to the balance of incentive-based compensation 
arrangements. Third, the proposed rule would extend coverage of

[[Page 37733]]

clawback mechanisms to include additional senior executive officers or 
significant risk-takers whose inappropriate risk-taking may not result 
in an accounting restatement, but would inflict harm on the covered 
institution nonetheless.
---------------------------------------------------------------------------

    \200\ See, e.g., notes 198 and 199. See also Dawn Kopecki, ``JP 
Morgan's Drew Forfeits 2 Years' Pay as Managers Ousted,'' Bloomberg 
Business (July 13, 2012); Dolia Estevez, ``Pay Slash to Citigroup's 
Top Mexican Executive Called `Humiliating,' '' Forbes (March 13, 
2014); Eyk Henning, ``Deutsche Bank Cuts Co-CEOs' Compensation,'' 
Wall Street Journal (March 20, 2015).
---------------------------------------------------------------------------

    This provision would go beyond, but not conflict with, clawback 
provisions in other areas of law.\201\ For example, covered 
institutions that issue securities also may be subject to clawback 
requirements pursuant to statutes administered by the SEC:
---------------------------------------------------------------------------

    \201\ See, e.g., section 304 of the Sarbanes-Oxley Act of 2002, 
15 U.S.C. 7243; section 111 of the Emergency Economic Stabilization 
Act of 2008, 12 U.S.C. 5221; section 210(s) of the Dodd-Frank Act, 
12 U.S.C. 5390(s); section 954 of the Dodd-Frank Act, 15 U.S.C. 78j-
4(b).
---------------------------------------------------------------------------

    [cir] Section 304 of the Sarbanes-Oxley Act of 2002 \202\ provides 
that if an issuer is required to prepare an accounting restatement due 
to the material noncompliance of the issuer, as a result of misconduct, 
with any financial reporting requirements under the securities laws, 
the CEO and chief financial officer of the issuer shall reimburse the 
issuer for (i) any bonus or other incentive-based or equity-based 
compensation received by that person from the issuer during the 12-
month period following the first public issuance or filing with the SEC 
(whichever first occurs) of the financial document embodying such 
financial reporting requirement and (ii) any profits realized from the 
sale of securities of the issuer during that 12-month period.
---------------------------------------------------------------------------

    \202\ 15 U.S.C. 7243.
---------------------------------------------------------------------------

    [cir] Section 954 of the Dodd-Frank Act added Section 10D to the 
Securities Exchange Act of 1934.\203\ Specifically, Section 10D(a) of 
the Securities Exchange Act requires the SEC to adopt rules directing 
the national securities exchanges \204\ and the national securities 
associations \205\ to prohibit the listing of any security of an issuer 
that is not in compliance with the requirements of Section 10D(b). 
Section 10D(b) requires the SEC to adopt rules directing the exchanges 
to establish listing standards to require each issuer to develop and 
implement a policy providing: (1) For the disclosure of the issuer's 
policy on incentive-based compensation that is based on financial 
information required to be reported under the securities laws; and (2) 
that, in the event that the issuer is required to prepare an accounting 
restatement due to the issuer's material noncompliance with any 
financial reporting requirement under the securities laws, the issuer 
will recover from any of the issuer's current or former executive 
officers who received incentive-based compensation (including stock 
options awarded as compensation) during the three-year period preceding 
the date the issuer is required to prepare the accounting restatement, 
based on the erroneous data, in excess of what would have been paid to 
the executive officer under the accounting restatement.
---------------------------------------------------------------------------

    \203\ 15 U.S.C. 78a et seq.
    \204\ A ``national securities exchange'' is an exchange 
registered as such under section 6 of the Exchange Act (15 U.S.C. 
78f). There are currently 18 exchanges registered under Section 6(a) 
of the Exchange Act: BATS Exchange, BATS Y-Exchange, BOX Options 
Exchange, C2 Options Exchange, Chicago Board Options Exchange, 
Chicago Stock Exchange, EDGA Exchange, EDGX Exchange, International 
Securities Exchange (``ISE''), ISE Gemini, Miami International 
Securities Exchange, NASDAQ OMX BX, NASDAQ OMX PHLX, The NASDAQ 
Stock Market, National Stock Exchange, New York Stock Exchange 
(``NYSE''), NYSE Arca and NYSE MKT.
    \205\ A ``national securities association'' is an association of 
brokers and dealers registered as such under Section 15A of the 
Exchange Act (15 U.S.C. 78o-3). The Financial Industry Regulatory 
Authority (``FINRA'') is the only association registered with the 
SEC under section 15A(a) of the Exchange Act, but FINRA does not 
list securities.
---------------------------------------------------------------------------

    The SEC has proposed rules to implement the requirements of 
Exchange Act Section 10D.\206\
---------------------------------------------------------------------------

    \206\ Listing Standards for Recovery of Erroneously Awarded 
Compensation, Release No. 33-9861 (July 1, 2015), 80 FR 41144 (July 
14, 2015).
---------------------------------------------------------------------------

    7.30. The Agencies invite comment on the clawback requirements of 
the proposed rule.
    7.31. Is a clawback requirement appropriate in achieving the goals 
of section 956? If not, why not?
    7.32. Is the seven-year period appropriate? Why or why not?
    7.33. Are there state contract or employment law requirements that 
would conflict with this proposed requirement? Are there challenges 
that would be posed by overlapping Federal clawback regimes? Why or why 
not?
    7.34. Do the triggers discussed above effectively achieve the goals 
of section 956? Should the triggers be based on those contained in 
section 954 of the Dodd-Frank Act?
    7.35. Should the Agencies provide additional guidance on the types 
of behavior that would constitute misconduct for purposes of section 
__.7(c)(1)?
    7.36. Should the rule include a presumption of some amount of 
clawback for particularly severe adverse outcomes? Why or why not? If 
so, what should be the amount and what would those outcomes be?

Sec.  __.8 Additional Prohibitions for Level 1 and Level 2 Covered 
Institutions

    Section __.8 of the proposed rule would establish additional 
prohibitions for Level 1 and Level 2 covered institutions to address 
practices that, in the view of the Agencies, could encourage 
inappropriate risks that could lead to material financial loss at 
covered institutions. The Agencies' views are based in part on 
supervisory experiences in reviewing and supervising incentive-based 
compensation at some covered institutions, as described earlier in this 
Supplemental Information section. Under the proposed rule, an 
incentive-based compensation arrangement at a Level 1 or Level 2 
covered institution would be considered to appropriately balance risk 
and reward, as required by section __.4(c)(1) of the proposed rule, 
only if the covered institution complies with the prohibitions of 
section __.8.

Sec.  __.8(a) Hedging

    Section __.8(a) of the proposed rule would prohibit Level 1 and 
Level 2 covered institutions from purchasing hedging instruments or 
similar instruments on behalf of covered persons to hedge or offset any 
decrease in the value of the covered person's incentive-based 
compensation. This prohibition would apply to all covered persons at a 
Level 1 or Level 2 covered institution, not just senior executive 
officers and significant risk-takers. Personal hedging strategies may 
undermine the effect of risk-balancing mechanisms such as deferral, 
downward adjustment and forfeiture, or may otherwise negatively affect 
the goals of these risk-balancing mechanisms and their overall efficacy 
in inhibiting inappropriate risk-taking.\207\ For example, a financial 
instrument, such as a derivative security that increases in value as 
the price of a covered institution's equity decreases would offset the 
intended balancing effect of awarding incentive-based compensation in 
the form of equity, the value of which is linked to the performance of 
the covered institution.
---------------------------------------------------------------------------

    \207\ This prohibition would not limit a covered institutions 
ability to hedge its own exposure in deferred compensation 
obligations, which the Board, the OCC, and the FDIC continue to view 
as prudent practice. (see, e.g., Federal Reserve SR Letter 04-19 
(Dec. 7, 2004); OCC Bulletin 2004-56 (Dec. 7, 2004); FDIC FIL-127-
2004 (Dec. 7, 2004); OCC Interpretive Letter No. 878 (Dec. 22, 
1999).
---------------------------------------------------------------------------

    Similarly, a hedging arrangement with a third party, under which 
the third party would make direct or indirect payments to a covered 
person that are linked to or commensurate with the amounts by which a 
covered person's incentive-based compensation is reduced by forfeiture, 
would protect the covered person against declines in the value of 
incentive-based compensation.

[[Page 37734]]

In order for incentive-based compensation to provide the appropriate 
incentive effects, covered persons should not be shielded from exposure 
to the negative financial impact of taking inappropriate risks or other 
aspects of their performance at the covered institution.
    In the 2011 Proposed Rule, the Agencies stated that they were aware 
that covered persons who received incentive-based compensation in the 
form of equity might wish to use personal hedging strategies as a way 
to assure the value of deferred equity compensation.\208\ The Agencies 
expressed concern that such hedging during deferral periods could 
diminish the alignment between risk and financial rewards that deferral 
arrangements might otherwise achieve.\209\ After considering 
supervisory experiences in reviewing incentive-based compensation at 
some covered institutions and the purposes of section 956 and related 
provisions of the Dodd-Frank Act, the Agencies are proposing a 
prohibition on covered institutions purchasing hedging and similar 
instruments on behalf of a covered person as a practical approach to 
eliminate the possibility that hedging during deferral periods could 
diminish the alignment between risk and financial rewards that deferral 
arrangements might otherwise achieve.
---------------------------------------------------------------------------

    \208\ See 76 FR at 21183.
    \209\ The Agencies note that one commenter to the 2011 Proposed 
Rule supported limits on hedging.
---------------------------------------------------------------------------

    8.1. The Agencies invite comment on whether this restriction on 
Level 1 and Level 2 covered institutions prohibiting the purchase of a 
hedging instrument or similar instrument on behalf of covered persons 
is appropriate to implement section 956 of the Dodd-Frank Act.
    8.2. Are there additional requirements that should be imposed on 
covered institutions with respect to hedging of the exposure of covered 
persons under incentive-based compensation arrangements?
    8.3. Should the proposed rule include a prohibition on the purchase 
of a hedging instrument or similar instrument on behalf of covered 
persons at Level 3 institutions?

Sec.  __.8(b) Maximum Incentive-Based Compensation Opportunity

    Section __.8(b) of the proposed rule would limit the amount by 
which the actual incentive-based compensation awarded to a senior 
executive officer or significant risk-taker could exceed the target 
amounts for performance measure goals established at the beginning of 
the performance period. It is the understanding of the Agencies that, 
under current practice, covered institutions generally establish 
performance measure goals for their covered persons at the beginning 
of, or early in, a performance period. At that time, under some 
incentive-based compensation plans, those covered institutions 
establish target amounts of incentive-based compensation that the 
covered persons can expect to be awarded if they meet the established 
performance measure goals. Some covered institutions also set out the 
additional amounts of incentive-based compensation, in excess of the 
target amounts, that covered persons can expect to be awarded if they 
or the covered institution exceed the performance measure goals. 
Incentive-based compensation plans commonly set out maximum awards of 
150 to 200 percent of the pre-set target amounts.\210\
---------------------------------------------------------------------------

    \210\ See, e.g., Arthur Gallagher & Co., ``Study of 2013 Short- 
and Long-Term Incentive Design Criterion Among Top 200 S&P 500 
Companies'' (December 5, 2014), available at http://www.ajg.com/media/1420659/study-of-2013-short-and-long-term-incentive-design-criterion-among-top-200.pdf.
---------------------------------------------------------------------------

    The proposed rule would prohibit a Level 1 or Level 2 covered 
institution from awarding incentive-based compensation to a senior 
executive officer in excess of 125 percent of the target amount for 
that incentive-based compensation. For a significant risk-taker the 
limit would be 150 percent of the target amount for that incentive-
based compensation. This limitation would apply on a plan-by-plan 
basis, and, therefore, would apply to long-term incentive plans 
separately from other incentive-based compensation plans.
    For example, a Level 1 covered institution might provide an 
incentive-based compensation plan for its senior executive officers 
that links the amount awarded to a senior executive officer to the 
covered institution's four-year average return on assets (ROA). The 
plan could establish a target award amount of $100,000 and a target 
four-year average ROA of 75 basis points. That is, if the covered 
institution's four-year average ROA was 75 basis points, a senior 
executive officer would receive $100,000. The plan could also provide 
that senior executive officers would earn nothing (zero percent of 
target) under the plan if ROA was less than 50 basis points; $60,000 
(60 percent of target) if ROA was 65 basis points; and $125,000 (125 
percent of target) if ROA was 100 basis points. Under the proposed 
rule, the plan would not be permitted to provide, for example, $130,000 
(130 percent of target) if ROA was 100 basis points or $150,000 (150 
percent of target) if ROA was 110 basis points.
    The Agencies are proposing these limits, in part, because they are 
consistent with the current industry practice at large banking 
organizations. Moreover, high levels of upside leverage (e.g., 200 
percent to 300 percent above the target amount) could lead to senior 
executive officers and significant risk-takers taking inappropriate 
risks to maximize the opportunity to double or triple their incentive-
based compensation. Recognizing the potential for inappropriate risk-
taking with such high levels of leverage, the Federal Banking Agencies 
have worked with large banking organizations to reduce leverage levels 
to a range of 125 percent to 150 percent. Such a range continues to 
provide for flexibility in the design and operation of incentive-based 
compensation arrangements in covered institutions while it addresses 
the potential for inappropriate risk-taking where leverage 
opportunities are large or uncapped. For a full example of how these 
requirements would work in practice, please see Appendix A of this 
Supplementary Information section.
    The proposed rule would set different maximums for senior executive 
officers and for significant risk-takers because senior executive 
officers and significant risk-takers have the potential to expose 
covered institutions to different types and levels of risk, and may be 
motivated by different types and amounts of incentive-based 
compensation. The Agencies intend the different limitations to reflect 
the differences between the risks posed by senior executive officers 
and significant risk-takers.
    The Agencies emphasize that the proposed limits on a covered 
employee's maximum incentive-based compensation opportunity would not 
equate to a ceiling on overall incentive-based compensation. Such 
limits would represent only a constraint on the percentage by which 
incentive-based compensation could exceed the target amount, and is 
aimed at prohibiting the use of particular features of incentive-based 
compensation arrangements which can contribute to inappropriate risk-
taking.
    8.4. The Agencies invite comment on whether the proposed rule 
should establish different limitations for senior executive officers 
and significant risk-takers, or whether the proposed rule should impose 
the same percentage limitation on senior executive officers and 
significant risk-takers.
    8.5. The Agencies also seek comment on whether setting a limit on 
the amount that compensation can grow from the time the target is 
established

[[Page 37735]]

until an award occurs would achieve the goals of section 956.
    8.6. The Agencies invite comment on the appropriateness of the 
limitation, i.e., 125 percent and 150 percent for senior executive 
officers and significant risk-takers, respectively. Should the 
limitations be set higher or lower and, if so, why?
    8.7. Should the proposed rule apply this limitation on maximum 
incentive-based compensation opportunity to Level 3 institutions?

Sec.  __.8(c) Relative Performance Measures

    Under section __.8(c) of the proposed rule, a Level 1 or Level 2 
covered institution would be prohibited from using incentive-based 
compensation performance measures based solely on industry peer 
performance comparisons. This prohibition would apply to incentive-
based compensation arrangements for all covered persons at a Level 1 or 
Level 2 covered institution, not just senior executive officers and 
significant risk-takers.
    As discussed above, covered institutions generally establish 
performance measures for covered persons at the beginning of, or early 
in, a performance period. For these types of plans, the performance 
measures (sometimes known as performance metrics) are the basis upon 
which a covered institution determines the related amounts of 
incentive-based compensation to be awarded to covered persons. These 
performance measures can be absolute, meaning they are based on the 
performance of the covered person or the covered institution without 
reference to the performance of other covered persons or covered 
institutions. In contrast, a relative performance measure is a 
performance measure that compares a covered institution's performance 
to that of so called ``peer institutions'' or an industry average. The 
composition of peer groups is generally decided by the individual 
covered institution. An example of an absolute performance measure is 
total shareholder return (TSR). An example of a relative performance 
measure is the rank of the covered institution's TSR among the TSRs of 
institutions in a pre-established peer group.
    The Agencies have observed that incentive-based compensation 
arrangements based solely on industry peer performance comparisons (a 
type of relative performance measure) can cause covered persons to take 
inappropriate risks that could lead to material financial loss.\211\ 
For example, if a covered institution falls behind its industry peers, 
it may use performance measures--and set goals for those measures--that 
lead to inappropriate risk-taking by covered persons in order to 
perform better than its industry peers. Also, the performance of a 
covered institution can be strong relative to its peers, but poor on an 
absolute basis (e.g., every institution in the peer group is performing 
poorly, but the covered institution is the best of the group). 
Consequently, if incentive-based compensation arrangements were based 
only on relative performance measures, they would, in that 
circumstance, reward covered employees for performance that is poor on 
an absolute level but still better than that of the covered 
institution's peer group. Similarly, in cases where only relative 
performance measures are used and performance is poor, performance-
based vesting may still occur when peer performance is also poor. Using 
a combination of relative and absolute performance measures as part of 
the performance evaluation process can help maintain balance between 
financial rewards and potential risks in such situations.
---------------------------------------------------------------------------

    \211\ Gong, Li, and Shin, ``Relative Performance Evaluation and 
Related Peer Groups in Executive Compensation Contracts,'' 86 The 
Accounting Review 1007 (May 2011).
---------------------------------------------------------------------------

    Additionally, covered persons do not know what level of performance 
is necessary to meet or exceed target peer group rankings, as rankings 
will become known only at the end of the performance period. As a 
result, covered employees may be strongly incentivized to achieve 
exceptional levels of performance by taking inappropriate risks to 
increase the likelihood that the covered institution will meet or 
exceed the peer group ranking in order to maximize their incentive-
based compensation.
    Further, comparing an institution's performance to a peer group can 
be misleading because the members of the peer group are likely to have 
different business models, product mixes, operations in different 
geographical locations, cost structures, or other attributes that make 
comparisons between institutions inexact.
    Relative performance measures, including industry peer performance 
measures, may be useful when used in combination with absolute 
performance measures. Thus, under the proposed rule, a covered 
institution would be permitted to use relative performance measures in 
combination with absolute performance measures, but not in isolation. 
For instance, a covered institution would not be in compliance with the 
proposed rule if the performance of the CEO were assessed solely on the 
basis of total shareholder return relative to a peer group. However, if 
the performance of the CEO were assessed on the basis of institution-
specific performance measures, such as earnings per share and return on 
tangible common equity, along with the same relative TSR the covered 
institution would comply with section __.8(c) of the proposed rule 
(assuming the CEO's incentive-based compensation arrangement met the 
other requirements of the rule, such as an appropriate balance of risk 
and reward).
    8.8. The Agencies invite comment on whether the restricting on the 
use of relative performance measures for covered persons at Level 1 and 
Level 2 covered institutions in section __.8(d) of the proposed rule is 
appropriate in deterring behavior that could put the covered 
institution at risk of material financial loss. Should this restriction 
be limited to a specific group of covered persons and why? What are the 
relative performance measures being used in industry?
    8.9. Should the proposed rule apply this restriction on the use of 
relative performance measures to Level 3 institutions?

Sec.  __.8(d) Volume-Driven Incentive-Based Compensation

    Section __.8(d) of the proposed rule would prohibit Level 1 and 
Level 2 covered institutions from providing incentive-based 
compensation to a covered person that is based solely on transaction or 
revenue volume without regard to transaction quality or the compliance 
of the covered person with sound risk management. Under the proposed 
rule, transaction or revenue volume could be used as a factor in 
incentive-based compensation arrangements, but only in combination with 
other factors designed to cause covered persons to account for the 
risks of their activities. This prohibition would apply to incentive-
based compensation arrangements for all covered persons at a Level 1 or 
Level 2 covered institution, not just senior executive officers and 
significant risk-takers.
    Incentive-based compensation arrangements that do not account for 
the risks covered persons can take to achieve performance measures do 
not appropriately balance risk and reward, as section __.4(c)(1) of the 
proposed rule would require. An arrangement that provides incentive-
based compensation

[[Page 37736]]

to a covered person based solely on transaction or revenue volume, 
without regard to other factors, would not adequately account for the 
risks to which the transaction in question could expose the covered 
institution. For instance, an incentive-based compensation arrangement 
that rewarded mortgage originators based solely on the volume of loans 
approved, without any subsequent adjustment for the quality of the 
loans originated (such as adjustments for early payment default or 
problems with representations and warranties) would not adequately 
balance risk and financial rewards.
    An incentive-based compensation arrangement with performance 
measures based solely on transaction or revenue volume could 
incentivize covered persons to generate as many transactions or as much 
revenue as possible without appropriate attention to resulting risks. 
Such arrangements were noted in MLRs and similar reports where 
compensation had been cited as a contributing factor to a financial 
institution's failure during the recent financial crisis.\212\ In 
addition, many studies about the causes of the recent financial crisis 
discuss how volume-driven incentive-based compensation lead to 
inappropriate risk-taking and caused material financial loss to 
financial institutions.\213\
---------------------------------------------------------------------------

    \212\ In accordance with section 38(k) of the FDIA, 12 U.S.C. 
1831o(k), MLRs are conducted by the Inspectors General of the 
appropriate Federal banking agency following the failure of insured 
depository institutions.
    See, e.g., Office of Inspector General for the Department of 
Treasury, ``Material Loss Review of Indymac Bank, FSB,'' OIG-09-032 
(February 26, 2009), available at http://www.treasury.gov/about/organizational-structure/ig/Documents/oig09032.pdf; Offices of 
Inspector General for the Federal Deposit Insurance Corporation and 
the Department of Treasury, ``Evaluation of Federal Regulatory 
Oversight of Washington Mutual Bank,'' EVAL-10-002 (April 9, 2010), 
available at https://www.fdicig.gov/reports10/10-002EV.pdf.
    \213\ See, e.g., Financial Crisis Inquiry Commission, ``The 
Financial Crisis Inquiry Report'' (January 2011), available at 
http://fcic-static.law.stanford.edu/cdn_media/fcic-reports/fcic_final_report_full.pdf.
---------------------------------------------------------------------------

    8.10. The Agencies invite comment on whether there are 
circumstances under which consideration of transaction or revenue 
volume as a sole performance measure goal, without consideration of 
risk, can be appropriate in incentive-based compensation arrangements 
for Level 1 or Level 2 covered institutions.
    8.11. Should the proposed rule apply this restriction on the use of 
volume-driven incentive-based compensation arrangements to Level 3 
institutions?

Sec.  __.9 Risk Management and Controls Requirements for Level 1 and 
Level 2 Covered Institutions

    Prior to the financial crisis that began in 2007, institutions 
rarely involved risk management in either the design or monitoring of 
incentive-based compensation arrangements. Federal Banking Agency 
reviews of compensation practices have shown that one important 
development in the intervening years has been the increasing 
integration of control functions in compensation design and decision-
making. For instance, control functions are increasingly relied on to 
ensure that risk is properly considered in incentive-based compensation 
programs. At the largest covered institutions, the role of the board of 
directors in oversight of compensation programs (including the 
oversight of supporting risk management processes) has also expanded.
    Section __.9 of the proposed rule would establish additional risk 
management and controls requirements at Level 1 and Level 2 covered 
institutions. Without effective risk management and controls, larger 
covered institutions could establish incentive-based compensation 
arrangements that, in the view of the Agencies,\214\ could encourage 
inappropriate risks that could lead to material financial loss at 
covered institutions. Under the proposed rule, an incentive-based 
compensation arrangement at a Level 1 or Level 2 covered institution 
would be considered to be compatible with effective risk management and 
controls, as required by section __.4(c)(2) of the proposed rule, only 
if the covered institution also complies with the requirements of 
section __.9. In proposing section __.9, the Agencies are also 
cognizant of comments received on the 2011 Proposed Rule.\215\ In order 
to facilitate consistent adoption of the practices that contribute to 
incentive-based compensation arrangements that appropriately balance 
risk and reward, the Agencies are proposing that the practices set 
forth in section __.9 be required for all Level 1 and Level 2 covered 
institutions.
---------------------------------------------------------------------------

    \214\ This view is based in part on supervisory experiences in 
reviewing and supervising incentive-based compensation at some 
covered institutions.
    \215\ The 2011 Proposed Rule would have required incentive-based 
compensation arrangements to be compatible with effective risk 
management and controls. A number of commenters offered views on the 
proposed requirements, and some raised concerns. Some commenters 
emphasized the importance of sound risk management practices in the 
area of incentive-based compensation. However, a number of 
commenters also questioned whether the determination of an 
``appropriate'' role for risk management personnel should be left to 
the discretion of individual institutions. In light of these 
comments, the proposed rule is designed to strike a reasonable 
balance between requiring an appropriate role for risk management 
and allowing institutions the ability to tailor their risk 
management practices to their business model. The proposed rule does 
not include prescriptive standards. Instead, it would allow Level 1 
and Level 2 covered institutions to retain flexibility to determine 
the specific role that risk management and control functions should 
play in incentive-based compensation processes, while still allowing 
for appropriate oversight of incentive-based compensation 
arrangements.
---------------------------------------------------------------------------

    Section __.9(a) of the proposed rule would establish minimum 
requirements for a risk management framework at a Level 1 or Level 2 
covered institution by requiring that such framework: (1) Be 
independent of any lines of business; (2) include an independent 
compliance program that provides for internal controls, testing, 
monitoring, and training with written policies and procedures 
consistent with section __.11 of the proposed rule; and (3) be 
commensurate with the size and complexity of the covered institution's 
operations.
    Generally, section __.9(a) would require that Level 1 and Level 2 
covered institutions have a systematic approach to designing and 
implementing their incentive-based compensation arrangements and 
incentive-based compensation programs supported by independent risk 
management frameworks with written policies and procedures, and 
developed systems. These frameworks would include processes and systems 
for identifying and reporting deficiencies; establishing managerial and 
employee responsibility; and ensuring the independence of control 
functions. To be effective, an independent risk management framework 
should have sufficient stature, authority, resources and access to the 
board of directors.
    Level 1 and Level 2 covered institutions would be required to 
develop, as part of their broader risk management framework, an 
independent compliance program for incentive-based compensation. The 
Federal Banking Agencies have found that an independent compliance 
program leads to more robust oversight of incentive-based compensation 
programs, helps to avoid undue influence by lines of business, and 
facilitates supervision. Agencies would expect such a compliance 
program to have formal policies and procedures to support compliance 
with the proposed rule and to help to ensure that risk is effectively 
taken into account in both design and decision-making processes related 
to incentive-based

[[Page 37737]]

compensation. The requirements for such policies and procedures are set 
forth in section __.11 of the proposed rule.
    The requirements of the proposed rule would encourage Level 1 and 
Level 2 covered institutions to develop well-targeted internal controls 
that work within the covered institution's broader risk management 
framework to support balanced risk-taking. Independent control 
functions should regularly monitor and test the covered institution's 
incentive-based compensation program and its arrangements to validate 
their effectiveness. Training would generally include communication to 
employees of the covered institution's compliance risk management 
standards and policies and procedures, and communication to managers on 
expectations regarding risk adjustment and documentation.
    The Agencies note that independent compliance programs consistent 
with these proposed requirements are already in place at a significant 
number of larger covered institutions, in part due to supervisory 
efforts such as the Board's ongoing horizontal review of incentive-
based compensation,\216\ Enhanced Prudential Standards from section 165 
of the Dodd-Frank Act,\217\ and the OCC's Heightened Standards.\218\ 
For example, control function employees monitor compliance with 
policies and procedures and help to ensure robust documentation of 
compensation decisions, including those relating to forfeiture and 
risk-adjustment processes. Institutions have also improved 
communication to managers and employees about how risk adjustment 
should work and have developed processes to review the application of 
related guidance in order to ensure better consideration of risk in 
compensation decisions. The Agencies are proposing to require similar 
compliance programs at covered institutions not subject to the 
supervisory efforts described above, as well as to reinforce the 
practices of covered institutions that already have such compliance 
programs in place.
---------------------------------------------------------------------------

    \216\ See 2011 FRB White Paper.
    \217\ See 12 CFR part 252.
    \218\ See 12 CFR part 30, appendix D.
---------------------------------------------------------------------------

    Section __.9(b) of the proposed rule would require Level 1 and 
Level 2 covered institutions to provide individuals engaged in control 
functions with the authority to influence the risk-taking of the 
business areas they monitor and to ensure covered persons engaged in 
control functions are compensated in accordance with the achievement of 
performance objectives linked to their control functions and 
independent of the performance of the business areas they oversee. 
These protections are intended to mitigate potential conflicts of 
interest that might undermine the role covered persons engaged in 
control functions play in supporting incentive-based compensation 
arrangements that appropriately balance risk and reward.
    Under section__.9(c) of the proposed rule, Level 1 and Level 2 
covered institutions would be required to provide for independent 
monitoring of: (1) Incentive-based compensation plans to identify 
whether those plans appropriately balance risk and reward; (2) events 
relating to forfeiture and downward adjustment reviews and decisions 
related thereto; and (3) compliance of the incentive-based compensation 
program with the covered institution's policies and procedures.
    To be considered independent under the proposed rule, the group or 
person at the covered institution responsible for monitoring the areas 
described above generally should have a reporting line to senior 
management or the board that is separate from the covered persons whom 
the group or person is responsible for monitoring. Some covered 
institutions may use internal audit to perform the independent 
monitoring that would be required under this section.\219\ The type of 
independent monitoring conducted to fulfill the requirements of section 
__.9(c) generally should be appropriate to the size and complexity of 
the covered institution and its use of incentive-based compensation. 
For example, a Level 1 covered institution might be expected to use a 
different scope and type of data and analysis to monitor its incentive-
based compensation program than a Level 2 covered institution. 
Likewise, a covered institution that offers incentive-based 
compensation to only a few employees may require a less formal 
monitoring process than a covered institution that offers many types of 
incentive-based compensation to many of its employees.
---------------------------------------------------------------------------

    \219\ At OCC-supervised institutions, the independent monitoring 
required under section __.9(c) would be carried out by internal 
audit.
---------------------------------------------------------------------------

    Section __.9(c)(1) of the proposed rule would require covered 
institutions to periodically review all incentive-based compensation 
plans to assess whether those plans provide incentives that 
appropriately balance risk and reward. Monitoring the incentives 
embedded in plans, rather than the individual arrangements that rely on 
those plans, provides an opportunity to identify incentives for 
imprudent risk-taking. It also reduces burden on covered institutions 
in a reasonable way in light of the proposed rule's additional 
protections against excessive risk-taking which operate at the level of 
incentive-based compensation arrangements. Supervisory experience 
indicates that many covered institutions already periodically perform 
such a review, and the Agencies consider it a better practice. Level 1 
and Level 2 covered institutions should have procedures for collecting 
information about the effects of their incentive-based compensation 
arrangements on employee risk-taking, and have systems and processes 
for using this information to adjust incentive-based compensation 
arrangements in order to eliminate or reduce unintended incentives for 
inappropriate risk-taking.
    Under Section __.9(c)(2), covered institutions would be required to 
provide for the independent monitoring of all events related to 
forfeiture and downward adjustment. With regard to forfeiture and 
downward adjustment decisions, covered institutions would be expected 
to regularly monitor the events that could trigger a forfeiture and 
downward adjustment review. Many covered institutions also regularly 
conduct independent monitoring and testing activities, or broad-based 
risk reviews, that could reveal instances of inappropriate risk-taking. 
The policies and procedures established under section __.11(b) would be 
expected to specify that covered institutions would evaluate whether 
inappropriate risk-taking identified in the course of any independent 
monitoring and testing activities triggered a forfeiture and downward 
adjustment review. The frequency of reviews may vary depending on the 
size and complexity of, and the level of risks at, the covered 
institution, but they should occur often enough to reasonably monitor 
risks and events related to the forfeiture and downward adjustment 
triggers.\220\ When these reviews uncover events that trigger 
forfeiture and downward adjustment reviews, Level 1 and Level 2 covered 
institutions would be required to complete such a review, consistent 
with the requirements of section __.7(b). They would also be required 
to monitor adherence to policies and procedures that support effective 
balancing of risk and rewards. Many covered institutions currently 
perform forfeiture reviews in the context of broader and more regular 
risk reviews to ensure that the forfeiture review process appropriately 
captures all risk-taking activity. The Agencies view this

[[Page 37738]]

approach as better practice, as decisions about appropriate adjustment 
of compensation in such circumstances are only one desired outcome. For 
instance, identification of risk events generally should lead not only 
to consideration of compensation adjustments, but also to analysis of 
whether there are weaknesses in broader controls or risk management 
oversight that need to be addressed. In their supervisory experience, 
the Federal Banking Agencies have found that tying forfeiture reviews 
to broader risk reviews is a better practice.
---------------------------------------------------------------------------

    \220\ See section __.7(b)(2).
---------------------------------------------------------------------------

    Section __.9(c)(3) of the proposed rule would require covered 
institutions to provide for independent compliance monitoring of the 
institution's incentive-based compensation program with policies and 
procedures. To be considered independent under the proposed rule, the 
group or person at the covered institution monitoring compliance should 
have a separate reporting line to senior management or to the board of 
directors from the business line or group being monitored, but may be 
conducted by groups within the covered institution. For example, 
internal audit could review whether award disbursement and vesting 
policies were adhered to and whether documentation of such decisions 
was sufficient to support independent review. Such independence will 
help ensure that the monitoring is unbiased and identifies appropriate 
issues.
    The Agencies have taken the position that Level 1 and Level 2 
covered institutions should regularly review whether the design and 
implementation of their incentive-based compensation arrangements 
deliver appropriate risk-taking incentives. Independent monitoring 
should enable covered institutions to correct deficiencies and make 
necessary improvements in a timely fashion based on the results of 
those reviews.\221\
---------------------------------------------------------------------------

    \221\ The 2010 Federal Banking Agency Guidance mentions several 
practices that can contribute to the effectiveness of such activity, 
including internal reviews and audits of compliance with policies 
and procedures, and monitoring of results relative to expectations. 
For instance, internal audit should assess the effectiveness of the 
compliance risk management program by performing regular independent 
reviews and evaluating whether internal controls, policies, and 
processes that limit incentive-based compensation risk are effective 
and appropriate for the covered institution's activities and 
associated risks.
---------------------------------------------------------------------------

    9.1 Some Level 1 and Level 2 covered institutions are subject to 
separate risk management and controls requirements under other 
statutory or regulatory regimes. For example, OCC-supervised Level 1 
and Level 2 covered institution are subject to the OCC's Heightened 
Standards. Is it clear to commenters how the risk management and 
controls requirements under the proposed rule would interact, if at 
all, with requirements under other statutory or regulatory regimes?

Sec.  __.10 Governance Requirements for Level 1 and Level 2 Covered 
Institutions

    Section __.10 of the proposed rule contains specific governance 
requirements that would apply to Level 1 and Level 2 covered 
institutions. Under the proposed rule, an incentive-based compensation 
arrangement at a Level 1 or Level 2 covered institution would be 
considered to be supported by effective governance, as required by 
section __.4(c)(3) of the proposed rule, only if the covered 
institution also complies with the requirements of section __.10.
    As discussed earlier in this Supplementary Information section, the 
supervisory experience of the Federal Banking Agencies at large 
consolidated financial institutions is that effective oversight by a 
covered institution's board of directors, including review and approval 
by the board of the overall goals and purposes of the covered 
institution's incentive-based compensation program, is essential to the 
attainment of incentive-based compensation arrangements that do not 
encourage inappropriate risks that could lead to material financial 
loss to the covered institution.
    Accordingly, section __.10(a) of the proposed rule would require 
that a Level 1 or Level 2 covered institution establish a compensation 
committee, composed solely of directors who are not senior executive 
officers, to assist the board in carrying out its responsibilities 
related to incentive-based compensation.\222\ Having an independent 
compensation committee is consistent with the emphasis the Agencies 
place on the need for incentive-based compensation arrangements to be 
compatible with effective risk management and controls and supported by 
effective governance. In response to the 2011 Proposed Rule, some 
commenters expressed a view that an independent compensation committee 
composed solely of non-management directors would have helped to avoid 
potential conflicts of interest and more appropriate consideration of 
management proposals, particularly proposed awards and payouts for 
senior executive officers.
---------------------------------------------------------------------------

    \222\ As described above, under the Board's and FDIC's proposed 
rules, for a foreign banking organization, ``board of directors'' 
would mean the relevant oversight body for the institution's U.S. 
branch, agency, or operations, consistent with the foreign banking 
organization's overall corporate and management structure. The Board 
and FDIC will work with foreign banking organizations to determine 
the appropriate persons to carry out the required functions of a 
compensation committee under the proposed rule. Likewise, under the 
OCC's proposed rule, for a Federal branch or agency of a foreign 
bank, ``board of directors'' would mean the relevant oversight body 
for the Federal branch or agency, consistent with its overall 
corporate and management structure. The OCC would work closely with 
Federal branches and agencies to determine the person or committee 
to undertake the responsibilities assigned to the oversight body.
---------------------------------------------------------------------------

    Section __.10(b) of the proposed rule would require that 
compensation committees at Level 1 and Level 2 covered institutions 
obtain input and assessments from various parties. For example, the 
compensation committees would be required to obtain input on the 
effectiveness of risk measures and adjustments used to balance risk and 
reward in incentive-based compensation arrangements from the risk and 
audit committees of the covered institution's board of directors, or 
groups performing similar functions, and from the covered institution's 
risk management function. The proposed requirements would help protect 
covered institutions against inappropriate risk-taking that could lead 
to material financial loss by leveraging the expertise and experience 
of these parties.
    In their review of the incentive-based compensation practices of 
many of the largest covered institutions, the Federal Banking Agencies 
have noted that the compensation, risk, and audit committees of the 
boards of directors collaborate and seek advice from risk management 
and other control functions before making decisions. Many of these 
covered institutions have members of the compensation committee that 
are also members of the risk and audit committees. Some covered 
institutions rely on regular meetings between the compensation and risk 
committees, while others rely on more ad hoc communications. Human 
resources, risk management, finance, and audit committees work with 
compensation committees to ensure that compensation systems attain 
multiple objectives, including appropriate risk-taking.\223\
---------------------------------------------------------------------------

    \223\ See generally 2011 FRB White Paper; FSB, ``FSB 2015 
Workshop on Compensation Practices'' (April 14, 2015), available at 
http://www.fsb.org/wp-content/uploads/Summary-of-the-April-2015-FSB-workshop-on-compensation-practices.pdf.
---------------------------------------------------------------------------

    Section __.10(b)(2) of the proposed rule would require the 
compensation committees to obtain from management, on an annual or more 
frequent basis, a written assessment of the covered institution's 
incentive-based compensation program and related compliance and control 
processes. The

[[Page 37739]]

report should assess the extent to which the program and processes 
provide risk-taking incentives that are consistent with the covered 
institution's risk profile. Management would be required to develop the 
assessment with input from the covered institutions' risk and audit 
committees, or groups performing similar functions, and from 
individuals in risk management and audit functions. In addition to the 
written assessment submitted by management, section __.10(b)(3) of the 
proposed rule would require the compensation committee to obtain 
another written assessment on the same matter, submitted on an annual 
or more frequent basis, by the internal audit or risk management 
function of the covered institution. This written assessment would be 
developed independently of the covered institution's management.
    The Agencies are proposing that the independent compensation 
committee of the board of directors to be the recipient of such input 
and written assessments.
    Developing incentive-based compensation arrangements that provide 
balanced risk-taking incentives and monitoring arrangements to ensure 
they achieve balance requires an understanding of the full spectrum of 
risks (including compliance risks) and potential risk outcomes 
associated with the activities of covered persons. For this reason, 
risk-management and other control functions generally should each have 
an appropriate role in the covered institution's processes, not only 
for designing incentive-based compensation arrangements, but also for 
assessing their effectiveness in providing risk-taking incentives that 
are consistent with the risk profile of the institution. The proposed 
rule sets forth two separate effectiveness assessments: (1) An 
assessment under the auspices of management, but reliant on risk 
management and audit functions, as well as the audit and risk 
committees of the board, and (2) an assessment conducted by the 
internal audit or risk management function of the covered institution, 
independent of management.
    In support of the first requirement, a covered institution's 
management has a full understanding of both the entirety of the covered 
institution's activities and a detailed understanding of its incentive-
based compensation program, including both the performance that the 
covered institution intends to reward and the risks to which covered 
persons can expose the covered institution. An understanding of the 
full compensation program (including the effectiveness of risk measures 
across various lines of business, the measurement of actual risk 
outcomes, and the analysis of risk-taking and risk outcomes relative to 
incentive-based compensation payments) requires a large degree of 
technical expertise. It also requires an understanding of the wider 
strategic and risk management frameworks in place at the covered 
institution (including the various objectives that compensation 
programs seek to balance, such as recruiting and retention goals and 
prudent risk management). While the board of directors at a covered 
institution is ultimately responsible for the balance of incentive-
based compensation arrangements, and for an incentive-based 
compensation program that incentivizes behaviors consistent with the 
long-term health of the organization, the board should generally hold 
senior management accountable for effectively executing the covered 
institution's incentive-based compensation program, and for modifying 
it when weaknesses are identified.
    In addition, some Level 1 and Level 2 covered institutions use 
automated systems to monitor the effectiveness of incentive-based 
compensation arrangements in balancing risk-taking incentives, 
especially systems that support capture of relevant data in databases 
that support monitoring and analysis. Management plays a role in all of 
these activities and is well-positioned to oversee an analysis that 
considers such a wide variety of inputs. In order to ensure that 
considerations of risk-taking are included in such an exercise, an 
active role for independent control functions is critical in such a 
review as well as input from the risk and audit committees of the board 
of directors, or groups performing similar functions. Periodic 
presentations by the chief risk officer or other risk management staff 
to the board of directors can help complement the annual effectiveness 
review.
    In addition, the proposed rule includes a requirement that internal 
audit or risk management submit a written assessment of the 
effectiveness of a Level 1 or Level 2 covered institution's incentive-
based compensation program and related control processes in providing 
risk-taking incentives that are consistent with the risk profile of the 
covered institution. Regular internal reviews and audits of compliance 
with policies and procedures are important to helping implement the 
incentive-based compensation system as intended by those employees 
involved in incentive-based compensation decision-making. Internal 
audit and risk management are well-positioned to provide an independent 
perspective on a covered institution's incentive-based compensation 
program and related control processes. The Federal Banking Agencies 
have observed that compensation committees benefit from an independent 
analysis of the effectiveness of their covered institutions' incentive-
based compensation programs.\224\
---------------------------------------------------------------------------

    \224\ For example, the 2010 Federal Banking Agency Guidance 
notes that a banking organization's risk-management processes and 
internal controls should reinforce and support the development and 
maintenance of balanced incentive compensation arrangements.
---------------------------------------------------------------------------

    The proposed requirement takes into consideration comments received 
on the policies and procedures standards embodied in the 2011 Proposed 
Rule that would have required the covered financial institution's board 
of directors, or a committee thereof, to receive data and analysis from 
management and other sources sufficient to allow the board, or 
committee thereof, to assess whether the overall design and performance 
of the institution's incentive-based compensation arrangements were 
consistent with section 956. Many commenters on the 2011 Proposed Rule 
expressed concern that the proposed requirements in the 2011 Proposed 
Rule would have inappropriately expanded the traditional ``oversight'' 
role of the board and would have required the board to exercise 
judgment in areas that traditionally have been--and, in the view of 
some commenters, are best left to--the expertise and prerogative of 
management. Commenters suggested that the proposed requirement instead 
place responsibility on management to conduct a formal assessment of 
the effectiveness of the covered institution's incentive-based 
compensation program and related compliance and control processes. The 
Agencies agree that management should be responsible for conducting 
such an assessment and section __.10(b)(2) of the proposed rule would 
thus place this responsibility on management, while requiring input 
from risk and audit committees, or groups performing similar functions, 
and from the covered institutions' risk management and audit functions. 
Under the proposed rule, the board's primary focus would be oversight 
of incentive-based compensation program and arrangements, while 
management would be expected to implement a program consistent with the 
vision of the board.
    10.1. The Agencies invite comment on this provision generally and 
whether the written assessments required under sections __.10(b)(2) and 
__.10(b)(3)

[[Page 37740]]

of the proposed rule should be provided to the compensation committee 
on an annual basis or at more or less frequent intervals?
    10.2. Are both reports required under Sec.  __.10(b)(2) and (3) 
necessary to aid the compensation committee in carrying out its 
responsibilities under the proposed rule? Would one or the other be 
more helpful? Why or why not?

Sec.  __.11 Policies and Procedures Requirements for Level 1 and Level 
2 Covered Institutions

    Section __.11 of the proposed rule would require Level 1 and Level 
2 covered institutions to develop and implement certain minimum 
policies and procedures relating to their incentive-based compensation 
programs. Requiring covered institutions to develop and follow policies 
and procedures related to incentive-based compensation would help both 
covered institutions and regulators identify the incentive-based 
compensation risks to which covered institutions are exposed, and how 
these risks are managed so as not to incentivize inappropriate risk-
taking by covered persons that could lead to material financial loss to 
the covered institution. The Agencies are not proposing to require 
specific policies and procedures of Level 3 covered institutions 
because these institutions are generally less complex and the impact to 
the financial system by risks taken at these covered institutions is 
not as significant as risks taken by covered persons at the larger, 
more complex covered institutions. In addition, by not requiring 
additional policies and procedures, Agencies intend to reduce burden on 
smaller covered institutions. In contrast, the larger Level 1 and Level 
2 covered institutions generally will have more complex organizations 
that tend to conduct a wide range of business activities and therefore 
will need robust policies and procedures as part of their compliance 
programs.\225\ Therefore, under section __.11 of the proposed rule, 
Level 3 covered institutions would not be subject to any specific 
requirements in this area, while Level 1 and Level 2 covered 
institutions would be required to develop and implement specific 
policies and procedures for their incentive-based compensation 
programs.
---------------------------------------------------------------------------

    \225\ See Federal Reserve SR Letter 08-08, ``Compliance Risk 
Management Programs and Oversight at Large Banking Organizations 
with Complex Compliance Profiles'' (October 16, 2008).
---------------------------------------------------------------------------

    Section __.11 of the proposed rule would identify certain areas 
that the policies and procedures of Level 1 and Level 2 covered 
institutions would, at a minimum, have to address. The list is not 
exhaustive. Instead, it is meant to indicate the policies and 
procedures that would, at a minimum, be necessary to carry out the 
requirements in other sections of the proposed rule.
    The development and implementation of the policies and procedures 
under section __.11 of the proposed rule would help to ensure and 
monitor compliance with the requirements set forth in section 956 and 
the other requirements in the proposed rule because the policies and 
procedures would set clear expectations for covered persons and allow 
the Agencies to better understand how a covered institution's 
incentive-based compensation program operates. Section __.11(a) of the 
proposed rule would contain the general requirement that the policies 
and procedures be consistent with the prohibitions and requirements 
under the proposed rule. Other parts of section __.11 of the proposed 
rule would help to ensure and monitor compliance with specific portions 
of the proposed rule.
    Under section __.11(b) of the proposed rule, a Level 1 or Level 2 
covered institution would have to develop and implement policies and 
procedures that specify the substantive and procedural criteria for the 
application of forfeiture and clawback, including the process for 
determining the amount of incentive-based compensation to be clawed 
back. These policies and procedures would provide covered persons with 
notice of the circumstances that would lead to forfeiture and clawback 
at their covered institutions, including any circumstances identified 
by the covered institution in addition to those required under the 
proposed rule. They would also help ensure consistent application of 
forfeiture and clawback by establishing a common set of expectations.
    Policies and procedures should make clear the triggers that will 
result in consideration of forfeiture, downward adjustment, and 
clawback; should indicate what individuals or committees are 
responsible for identifying, escalating and resolving these issues in 
such cases; should ensure that control functions contribute relevant 
information and participate in any decisions; and should set out a 
clear process for determining responsibility for the events triggering 
the forfeiture and downward adjustment review including provisions 
requiring appropriate input from covered employees under consideration 
for forfeiture or clawback.
    The proposed rule also would require that Level 1 and Level 2 
covered institutions' policies and procedures require the maintenance 
of documentation of final forfeiture, downward adjustment, and clawback 
decisions under section __.11(c) of the proposed rule. Documentation 
would allow control functions and the Agencies to evaluate compliance 
with the requirements of section __.7 of the proposed rule. The 
Agencies are proposing this requirement because they have found that it 
is critical that forfeiture and downward adjustment reviews at covered 
institutions be supported by effective governance to ensure 
consistency, fairness and robustness of all related decision-making.
    Section __.11(d) of the proposed rule would include a requirement 
for policies and procedures of Level 1 and Level 2 covered institutions 
that would specify the substantive and procedural criteria for 
acceleration of payments of deferred incentive-based compensation to a 
covered person consistent with sections __.7(a)(1)(iii)(B) and 
__.7(a)(2)(iii)(B) of the proposed rule. Under section __.7 of the 
proposed rule, acceleration of vesting of incentive-based compensation 
that is required to be deferred under such section would only be 
permitted in the case of death or disability. A Level 1 or Level 2 
covered institution would have to have policies and procedures that 
describe how disability would be evaluated for purposes of determining 
whether to accelerate payments of deferred incentive-based 
compensation.
    Section __.11(e) would require Level 1 and Level 2 covered 
institutions to have policies and procedures that identify and describe 
the role of any employees, committees, or groups authorized to make 
incentive-based compensation decisions, including when discretion is 
authorized. A Level 1 or Level 2 covered institution's policies and 
procedures would also have to describe how discretion is expected to be 
exercised in order to appropriately balance risk and reward and how the 
incentive-based compensation arrangements will be monitored under 
sections __.11(f) and (h) of the proposed rule, respectively.
    Related to the requirements regarding disclosure under sections 
__.4(f) and __.5 of the proposed rule, under section __.11(g), a Level 
1 or Level 2 covered institution would need to have policies and 
procedures that require the covered institution to maintain 
documentation of the establishment, implementation, modification, and 
monitoring of incentive-based

[[Page 37741]]

compensation arrangements sufficient to support the covered 
institution's decisions. Section __.11(i) would require the policies 
and procedures to specify the substantive and procedural requirements 
of the independent compliance program, consistent with section 
__.9(a)(2). And section __.11(j) would require policies and procedures 
that address the appropriate roles for risk management, risk oversight, 
and other control function personnel in the covered institution's 
processes for (1) designing incentive-based compensation arrangements 
and determining awards, deferral amounts, deferral periods, forfeiture, 
downward adjustment, clawback, and vesting, and (2) assessing the 
effectiveness of incentive-based compensation arrangements in 
restraining inappropriate risk-taking.
    The Agencies anticipate that some Level 1 and Level 2 covered 
institutions that have international operations might choose to adopt 
enterprise-wide incentive-based compensation policies and procedures. 
The Agencies recognize that such policies and procedures, when utilized 
by various subsidiary institutions, may need to be further modified to 
reflect local regulation and the requirements of home country 
regulators in the case of international institutions and tailored to a 
certain extent by line of business, legal entity, or business model.
    11.1. The Agencies invite general comment on the proposed policies 
and procedures requirements for Level 1 and Level 2 covered 
institutions under section __.11 of the proposed rule.

Sec.  __.12 Indirect Actions

    Section __.12 of the proposed rule would prohibit a covered 
institution from doing indirectly what it cannot do directly under the 
proposed rule. Section __.12 would apply all of the proposed rule's 
requirements and prohibitions to actions taken by covered institutions 
indirectly or through or by any other person. Section __.12 is 
substantially the same as section __.7 of the 2011 Proposed Rule. The 
Agencies did not receive any comments on section __.7 of the 2011 
Proposed Rule.
    By subjecting such indirect actions by covered institutions to all 
of the proposed rule's requirements and prohibitions, section __.12 
would implement the directive in section 956(b) to adopt rules that 
prohibit any type of incentive-based payment arrangement, or any 
feature of any such arrangement, that the Agencies determine encourages 
inappropriate risks by covered institutions (1) by providing excessive 
compensation, fees, or benefits or (2) that could lead to material 
financial loss. The Agencies are concerned that a covered institution 
may take indirect actions in order to avoid application of the proposed 
rule's requirements and prohibitions. For example, a covered 
institution could attempt to make substantial numbers of its covered 
persons independent contractors for the purpose of avoiding application 
of the proposed rule's requirements and prohibitions. A covered 
institution could also attempt to make substantial numbers of its 
covered persons employees of another entity for the purpose of avoiding 
application of the proposed rule's requirements and prohibitions. If 
left unchecked, such indirect actions could encourage inappropriate 
risk-taking by providing covered persons with excessive compensation or 
could lead to material financial loss at a covered institution.
    The Agencies, however, do not intend to disrupt indirect actions, 
including independent contractor or employment relationships, not 
undertaken for the purpose of avoiding application of the proposed 
rule's requirements and prohibitions. Thus, the Agencies would apply 
the proposed rule regardless of how covered institutions classify their 
actions, while also recognizing that covered institutions may 
legitimately engage in activities that are outside the scope of section 
956 and the proposed rule.\226\
---------------------------------------------------------------------------

    \226\ The Agencies note, however, that section 956 of the Dodd-
Frank Act does not, and the proposed rule would not, limit the 
authority of the Agencies under other provisions of applicable law 
and regulations.
---------------------------------------------------------------------------

    NCUA's proposed rule also would clarify that covered credit unions 
may not use CUSOs to avoid the requirements of the proposed rule, such 
as by using CUSOs to maintain non-compliant incentive-based 
compensation arrangements on behalf of senior executive officers or 
significant risk-takers of Federally insured credit unions.
    12.1. Commenters are invited to address all aspects of section 
__.12, including any examples of other indirect actions that the 
Agencies should consider.

Sec.  __.13 Enforcement

    By its terms, section 956 applies to any depository institution and 
any depository institution holding company (as those terms are defined 
in section 3 of the FDIA), any broker-dealer registered under section 
15 of the Securities Exchange Act, any credit union, any investment 
adviser (as that term is defined in the Investment Advisers Act of 
1940), the Federal National Mortgage Association, and the Federal Home 
Loan Mortgage Corporation. Section 956 also applies to any other 
financial institution that the appropriate Federal regulators jointly 
by rule determine should be treated as a covered financial institution 
for purposes of section 956.
    Section 956(d) also specifically sets forth the enforcement 
mechanism for rules adopted under that section. The statute provides 
that section 956 and the implementing rules shall be enforced under 
section 505 of the Gramm-Leach-Bliley Act and that a violation of 
section 956 or the regulations under section 956 will be treated as a 
violation of subtitle A of Title V of the Gramm-Leach-Bliley Act.
    Section 505 of the Gramm-Leach-Bliley Act provides for enforcement 
under section 1818 of title 12, by the appropriate Federal banking 
agency, as defined in section 1813(q) of title 12,\227\ in the case of 
national banks, Federal branches and Federal agencies of foreign banks, 
and any subsidiaries of such entities (except brokers, dealers, persons 
providing insurance, investment companies, and investment advisers); 
member banks of the Federal Reserve System (other than national banks), 
branches and agencies of foreign banks (other than Federal branches, 
Federal agencies, and insured State branches of foreign banks), 
commercial lending companies owned or controlled by foreign banks, 
organizations operating under section 25 or 25A of the Federal Reserve 
Act [12 U.S.C. 601 et seq., 611 et seq.], and bank holding companies 
and their nonbank subsidiaries or affiliates (except brokers, dealers, 
persons providing insurance, investment companies, and investment 
advisers); as well as banks insured by the FDIC (other than members of 
the Federal Reserve System), insured State branches of foreign banks, 
and any subsidiaries of such entities (except brokers, dealers, persons 
providing insurance, investment companies, and investment advisers); 
and savings associations the deposits of which are insured by the FDIC, 
and any subsidiaries of such savings associations (except brokers, 
dealers, persons providing insurance, investment companies, and 
investment advisers).
---------------------------------------------------------------------------

    \227\ For purposes of section 1813(q), the appropriate Federal 
banking agency for institutions listed in paragraphs (A) and (D) is 
the OCC; for institutions listed in paragraphs (B), the Board; and 
for institutions listed in paragraph (C), the FDIC. 12 U.S.C. 
1813(q).
---------------------------------------------------------------------------

    The Gramm-Leach-Bliley Act also provides for enforcement under the 
following: (1) Federal Credit Union Act

[[Page 37742]]

[12 U.S.C. 1751 et seq.], by the Board of the NCUA with respect to any 
federally insured credit union, and any subsidiaries of such an entity; 
(2) the Securities Exchange Act of 1934 [15 U.S.C. 78a et seq.], by the 
SEC with respect to any broker or dealer; (3) the Investment Company 
Act of 1940 [15 U.S.C. 80a-1 et seq.], by the SEC with respect to 
investment companies; (4) the Investment Advisers Act of 1940 [15 
U.S.C. 80b-1 et seq.], by the SEC with respect to investment advisers 
registered with the Commission under such Act; (5) State insurance law, 
in the case of any person engaged in providing insurance, by the 
applicable State insurance authority of the State in which the person 
is domiciled, subject to section 6701 of the Gramm-Leach-Bliley Act; 
(6) the Federal Trade Commission Act [15 U.S.C. 41 et seq.], by the 
Federal Trade Commission for any other financial institution or other 
person that is not subject to the jurisdiction of any agency or 
authority listed above; and (7) subtitle E of the Consumer Financial 
Protection Act of 2010 [12 U.S.C. 5561 et seq.], by the Bureau of 
Consumer Financial Protection, in the case of any financial institution 
and other covered person or service provider that is subject to the 
jurisdiction of the Bureau.
    The proposed rule includes these enforcement provisions as provided 
in section 956.
    FHFA's enforcement authority for the proposed rule derives from its 
authorizing statute, the Safety and Soundness Act. FHFA is not one of 
the ``Federal functional regulators'' listed in section 505 of the 
Gramm-Leach-Bliley Act. Additionally, the applicability of Title V of 
the Gramm-Leach-Bliley Act to Fannie Mae and Freddie Mac is limited by 
their conditional exclusion from that Title's definition of ``financial 
institution.'' But there is no evidence that Congress intended to 
exclude FHFA, or Fannie Mae and Freddie Mac, from enforcement of the 
proposed rule. To the contrary, Congress specifically included Fannie 
Mae and Freddie Mac as covered financial institutions and FHFA as an 
``appropriate federal regulator'' in section 956, and FHFA requires no 
additional enforcement authority. The Safety and Soundness Act provides 
FHFA with enforcement authority for all laws and regulations that apply 
to its regulated entities.
    13.1. The Agencies invite comment on all aspects of section __.13.

Sec.  __.14 NCUA and FHFA Covered Institutions in Conservatorship, 
Receivership, or Liquidation

    The NCUA's and FHFA's proposed rules each include a section __.14 
that would address those instances when a covered institution is placed 
in conservatorship, receivership, or liquidation, including limited-
life regulated entities, under their respective authorizing statutes, 
the Federal Credit Union Act or the Safety and Soundness Act.\228\ If a 
covered institution is placed in conservatorship, receivership, or 
liquidation, the conservator, receiver, or liquidating agent, 
respectively, and not the covered institution's board or management, 
has ultimate authority over all compensation arrangements, including 
any incentive-based compensation for covered persons. When determining 
or approving any incentive-based compensation plans for covered persons 
at such a covered institution, the conservator, receiver, or 
liquidating agent will implement the purposes of the Dodd-Frank Act by 
prohibiting excessive incentive-based compensation and incentive-based 
compensation that encourages inappropriate risk-taking.
---------------------------------------------------------------------------

    \228\ The FDIC's proposed rule would not apply to institutions 
for which the FDIC is appointed receiver under the FDIA or Title II 
of the Dodd-Frank Act, as appropriate, as those statutes govern such 
cases.
---------------------------------------------------------------------------

    Institutions placed in conservatorship, receivership, or 
liquidation may be subject to different needs and circumstances with 
respect to attracting and retaining talent than other types of covered 
institutions. In order to attract and retain qualified individuals at a 
covered institution in conservatorship, for example, the conservator 
may determine that while a significant portion of a covered person's 
incentive-based compensation should be deferred, due to the uncertain 
future of the covered institution in conservatorship, the deferral 
period would be shorter than that set forth in the deferral provisions 
of the proposed rule. In another example, where a conservator assumes 
the roles and responsibilities of the covered institution's board and 
its committees, the conservator may determine that it is not necessary 
for the board of the covered institution, if any remains in 
conservatorship, to approve a material adjustment to a senior executive 
officer's incentive-based compensation arrangement as described by the 
governance section of the proposed rule.
    Certain provisions of the proposed rule, such as the deferral and 
governance provisions, may not be appropriate for institutions in 
conservatorship, receivership, or liquidation, and the incentive-based 
compensation structure that best meets their needs while implementing 
the purposes of the Dodd-Frank Act is appropriately left to the 
conservator, receiver, or liquidating agent, respectively. Under the 
applicable section __.14 of the proposed rule, if a covered institution 
is placed in conservatorship, receivership, or liquidation under the 
Safety and Soundness Act, for FHFA's proposed rule, or the Federal 
Credit Union Act, for the NCUA's proposed rule, the respective 
conservator, receiver, or liquidating agent would have the 
responsibility to fulfill the requirements and purposes of 12 U.S.C. 
5641. The conservator, receiver, or liquidating agent also has the 
discretion to determine transition terms should the covered institution 
cease to be in conservatorship, receivership, or liquidation.
    14.1. Commenters are invited to address all aspects of section 
__.14 of the proposed rule.

SEC Amendment to Exchange Act Rule 17a-4

    The SEC is proposing an amendment to Exchange Act Rule 17a-4(e) (17 
CFR 240.17a-4(e)) to require that broker-dealers maintain the records 
required by Sec.  __.4(f), and for Level 1 and Level 2 broker-dealers, 
Sec. Sec.  __.5 and __.11, in accordance with the recordkeeping 
requirements of Exchange Act Rule 17a-4. Exchange Rule 17a-4 
establishes the general formatting and storage requirements for records 
that broker-dealers are required to keep. For the sake of consistency 
with other broker-dealer records, the SEC believes that broker-dealers 
should also keep the records required by Sec.  __.4(f), and for Level 1 
and Level 2 broker-dealers, Sec. Sec.  __.5 and __.11, in accordance 
with these requirements.
    New paragraph (e)(10) of Exchange Act Rule 17a-4 would require 
Level 1, Level 2, and Level 3 broker-dealers to maintain and preserve 
in an easily accessible place the records required by Sec.  __.4(f), 
and for Level 1 and Level 2 broker-dealers, the records required by 
Sec. Sec.  __.5 and __.11. Paragraph (f) of Exchange Act Rule 17a-4 
provides that the records a broker-dealer is required to maintain and 
preserve under Exchange Act Rule 17a-3 (17 CFR 240.17a-3) and Exchange 
Act Rule 17a-4 may be immediately produced or reproduced on 
micrographic media or by means of electronic storage media. Paragraph 
(j) of Exchange Act Rule 17a-4 requires a broker-dealer, which would 
include a

[[Page 37743]]

broker-dealer that is a Level 1, Level 2, or Level 3 covered 
institution pursuant to the proposed rules, to furnish promptly to a 
representative of the SEC legible, true, complete, and current copies 
of those records of the broker-dealer that are required to be preserved 
under Exchange Act Rule 17a-4, or any other records of the broker-
dealer subject to examination under section 17(b) of the Securities 
Exchange Act of 1934 that are requested by the representative.\229\
---------------------------------------------------------------------------

    \229\ For a discussion generally of Exchange Act Rule 17a-4, see 
Recordkeeping and Reporting Requirements for Security-Based Swap 
Dealers, Major Security-Based Swap Participants, and Broker-Dealers; 
Capital Rule for Certain Security-Based Swap Dealers, Release No. 
34-71958 (Apr. 17, 2014), 79 FR 25194 (May 2, 2014).
---------------------------------------------------------------------------

SEC Amendment to Investment Advisers Act Rule 204-2

    The SEC is proposing an amendment to rule 204-2 under the 
Investment Advisers Act (17 CFR 275.204-2) to require that investment 
advisers registered or required to be registered under section 203 of 
the Investment Advisers Act (15 U.S.C. 80b-3) maintain the records 
required by Sec.  __.4(f) and, for those investment advisers that are 
Level 1 or Level 2 covered institutions, Sec. Sec.  __.5 and __.11, in 
accordance with the recordkeeping requirements of rule 204-2. New 
paragraph (a)(19) of rule 204-2 would require investment advisers 
subject to rule 204-2 that are Level 1, Level 2, or Level 3 covered 
institutions to make and keep true, accurate, and current the records 
required by, and for the period specified in, Sec.  __.4(f) and, for 
those investment advisers that are Level 1 or Level 2 covered 
institutions, the records required by, and for the periods specified 
in, Sec. Sec.  __.5 and __.11.
    Rule 204-2 establishes the general recordkeeping requirements for 
investment advisers registered or required to be registered under 
section 203 of the Investment Advisers Act. For the sake of consistency 
with other investment adviser records, the SEC is proposing that this 
rule require such investment advisers that are covered institutions to 
keep the records required by Sec.  __.4(f) and those that are Level 1 
or Level 2 covered institutions to keep the records required by 
Sec. Sec.  __.5 and __.11 in accordance with the requirements of rule 
204-2.

III. Appendix to the Supplementary Information: Example Incentive-Based 
Compensation Arrangement and Forfeiture and Downward Adjustment Review

    For an incentive-based compensation arrangement to meet the 
requirements of the proposed rule, particularly the requirement that 
such an arrangement appropriately balance risk and reward, covered 
institutions would need to look holistically at the entire incentive-
based arrangement. Below, for purposes of illustration only, the 
Agencies outline an example of a hypothetical incentive-based 
compensation arrangement that would meet the requirements of the 
proposed rule and an example of how a forfeiture and downward 
adjustment review might be conducted. These illustrations do not cover 
every aspect of the proposed rule. They are provided as an aid to 
understanding the proposed rule and would not carry the force and 
effect of law or regulation, if issued as a companion to a final rule. 
Reviewing these illustrations does not substitute for a review of the 
proposed rule.
    This example assumes that the final rule was published as proposed 
and all incentive-based compensation programs and arrangements were 
required to comply on or before January 1, 2020.

Ms. Ledger: Senior Executive Officer at Level 2 Covered Institution

    Ms. Ledger is the chief financial officer at a bank holding 
company, henceforth ``ABC,'' which has $200 billion in average total 
consolidated assets. Under the definitions of the proposed rule Ms. 
Ledger would be a senior executive officer and ABC would be a Level 2 
covered institution.\230\
---------------------------------------------------------------------------

    \230\ See the definitions of ``senior executive officer'' and 
``Level 2 covered institution'' in section __.2 of the proposed 
rule.
---------------------------------------------------------------------------

    Ms. Ledger is provided incentive-based compensation under three 
separate incentive-based compensation plans. The first plan, the 
``Annual Executive Plan,'' is applicable to all senior executive 
officers at ABC, and requires assessment over the course of one 
calendar year. The second plan, the ``Annual Firm-Wide Plan,'' is 
applicable to all employees at ABC, and is also based on a one-year 
performance period that coincides with the calendar year. The third 
plan, ``Ms. Ledger's LTIP,'' is applicable only to Ms. Ledger, and 
requires assessment of performance over a three-year performance period 
that begins on January 1 of year 1 and ends on December 31 of year 3. 
These three plans together comprise Ms. Ledger's incentive-based 
compensation arrangement.
    The proposed rule would impose certain requirements on Ms. Ledger's 
incentive-based compensation arrangement. Section __.4(a)(1) of the 
proposed rule would require that Ms. Ledger's entire incentive-based 
compensation arrangement, and each feature of that arrangement, not 
provide excessive compensation. ABC would be required to consider the 
six factors listed in section __.4(b) of the proposed rule, as well as 
any other factors that ABC finds relevant, in evaluating whether Ms. 
Ledger's incentive-based compensation arrangement provides excessive 
compensation before approving Ms. Ledger's incentive-based compensation 
arrangement.

Balance

    Under section __.4(c)(1) of the proposed rule, the entire 
arrangement would be required to appropriately balance risk and reward. 
ABC would be expected to consider the risks that Ms. Ledger's 
activities pose to the institution, and the performance that Ms. 
Ledger's incentive-based compensation arrangement rewards. ABC might 
consider both the type and target level of any associated performance 
measures; how all performance measures would work together under the 
three plans; the form of incentive-based compensation; the recourse ABC 
has to reduce incentive-based compensation once awarded (through 
forfeiture) \231\ including under the conditions outlined in section 
__.7 of the proposed rule; the ability ABC has to use clawback of 
incentive-based compensation once vested, including under the 
conditions outlined in section __.7 of the proposed rule; and any 
overlapping performance periods of the various incentive-based 
compensation plans, which apply to Ms. Ledger.
---------------------------------------------------------------------------

    \231\ This requirement for balance under section __.4(c)(1) 
would not, however require forfeiture, or any specific forfeiture 
measure, for any particular covered person. As discussed below, 
sections __.7 and __.8 contain specific requirements applicable to 
senior executive officers at Level 1 and Level 2 covered 
institutions.
---------------------------------------------------------------------------

    Under section __.4(d) of the proposed rule, Ms. Ledger's incentive-
based compensation arrangement would be required to include both 
financial and non-financial measures of performance. These measures 
would need to include considerations of risk-taking that are relevant 
to Ms. Ledger's role within ABC and to the type of business in which 
Ms. Ledger is engaged. They also would need to be appropriately 
weighted to reflect risk-taking. The arrangement would be required to 
allow non-financial

[[Page 37744]]

measures of performance to override financial measures of performance 
when appropriate in determining Ms. Ledger's incentive-based 
compensation. Any amounts to be awarded under Ms. Ledger's arrangement 
would be subject to adjustment to reflect ABC's actual losses, 
inappropriate risks Ms. Ledger took or was accountable for others 
taking, compliance deficiencies Ms. Ledger was accountable for, or 
other measures or aspects of Ms. Ledger's and ABC's financial and non-
financial performance. For example, the Annual Firm-Wide Plan might use 
a forward-looking internal profit measure that takes into account 
stressed conditions as a proxy for liquidity risk that Ms. Ledger's 
activities pose to ABC and thus mitigates against incentives to take 
imprudent liquidity risk. It might also include limits on liquidity 
risk, the repeated breach of which would result in non-compliance with 
a key non-financial performance objective.
    In practice, each incentive-based compensation plan will include 
various measures of performance, and under the proposed rule, each plan 
would be required to include both financial and non-financial measures. 
The Annual Firm-Wide Plan may be largely based on the change in value 
of ABC's equity over the performance year, but that cannot be the only 
basis for incentive-based compensation awarded under that plan. Non-
financial measures of Ms. Ledger's risk-taking activity would have to 
be taken into account in determining the incentive-based compensation 
awarded under that plan, and those non-financial measures would need to 
be appropriately weighted so that they could override financial 
measures. Even if ABC's equity performed very well over the performance 
year, if Ms. Ledger was found to have violated risk performance 
measures, Ms. Ledger should not be awarded the full target of 
incentive-based compensation from the plan.
    Because Ms. Ledger is a senior executive officer at a Level 2 
covered institution, Ms. Ledger's incentive-based compensation 
arrangement would not be considered to appropriately balance risk and 
reward unless it was structured to be consistent with the requirements 
set forth in sections __.7 and __.8 of the proposed rule. The 
incentive-based compensation awarded to Ms. Ledger would not be 
permitted to be based solely on relative performance measures \232\ or 
be based solely on transaction revenue or volume.\233\ The Annual 
Executive Plan may include a measure of ABC's TSR relative to its peer 
group, but that plan would comply with the proposed rule only if other 
absolute measures of ABC's or Ms. Ledger's performance were also 
included (e.g., achievement of a three-year average return on risk 
adjusted capital). Similarly, a plan that applied to significant risk-
takers who were engaged in trading might include transaction volume as 
one of the financial performance measures, but that plan would comply 
with the proposed rule only if it also included other factors, such as 
measurement of transaction quality or the significant risk-taker's 
compliance with the institution's risk-management policies.
---------------------------------------------------------------------------

    \232\ See section __.8(c) of the proposed rule.
    \233\ See section __.8(d) of the proposed rule.
---------------------------------------------------------------------------

Award of Incentive-Based Compensation for Performance Periods Ending 
December 31, 2024

    Ms. Ledger's incentive-based compensation is awarded on January 31, 
2025. The Annual Executive Plan and the Annual Firm-Wide Plan are 
awarded on this date for the performance period starting on January 1, 
2024 and ending on December 31, 2024. Ms. Ledger's LTIP will be awarded 
on this date for the performance period starting on January 1, 2022 and 
ending on December 31, 2024. This example assumes ABC's share price on 
December 31, 2024 (the end of the performance period) is $50.
    Ms. Ledger's target incentive-based compensation award amount under 
the Annual Executive plan is $60,000 and 1,000 shares of ABC.\234\ 
Under the Annual Firm-Wide Plan, Ms. Ledger's target incentive-based 
compensation award amount is $30,000. Finally, under Ms. Ledger's LTIP, 
her target incentive-based compensation award amount is $40,000 and 
2,000 shares of ABC.
---------------------------------------------------------------------------

    \234\ That is, if Ms. Ledger meets all of the performance 
measure targets set out under that plan, she will be awarded both 
$60,000 in cash and 1,000 shares of ABC stock.
---------------------------------------------------------------------------

    To be consistent with the proposed rule, the maximum incentive-
based compensation amounts that ABC would be allowed to award to Ms. 
Ledger are 125 percent of the target amount, which would amount to: 
$75,000 and 1,250 shares under the Annual Executive Plan; $37,500 under 
the Annual Firm-Wide Plan; and $50,000 and 2,500 shares under Ms. 
Ledger's LTIP.
    If Ms. Ledger were implicated in a forfeiture and downward 
adjustment review during the performance period, ABC would be expected 
to consider whether and by what amount to reduce the amounts awarded to 
Ms. Ledger. As part of that review, ABC would be expected to consider 
all of the amounts that could be awarded to Ms. Ledger under the Annual 
Executive Plan, Annual Firm-Wide Plan, and Ms. Ledger's LTIP for 
downward adjustment before any incentive-based compensation were 
awarded to Ms. Ledger.\235\
---------------------------------------------------------------------------

    \235\ See section __.7(b) of the proposed rule.
---------------------------------------------------------------------------

    Regardless of whether a downward forfeiture and downward adjustment 
review occurred, ABC would be expected to evaluate Ms. Ledger's 
performance, including Ms. Ledger's risk-taking activities, at or near 
the end of the performance period (December 31, 2024). ABC would be 
required to use non-financial measures of performance, and particularly 
measures of risk-taking, to determine Ms. Ledger's incentive-based 
compensation award, possibly decreasing the amount Ms. Ledger would be 
awarded if only financial measures were taken into account.\236\
---------------------------------------------------------------------------

    \236\ See section __.4(d)(2) of the proposed rule.
---------------------------------------------------------------------------

    Based on performance and taking into account Ms. Ledger's risk-
taking behavior, ABC decides to award Ms. Ledger: $30,000 and 1,000 
shares under the Annual Executive Plan; $35,000 under the Annual Firm-
Wide Plan; and $40,000 and 2,000 shares under Ms. Ledger's LTIP. 
Valuing the ABC equity at the time of award, the total value of Ms. 
Ledger's award under the Annual Executive Plan is $80,000, under the 
Annual Firm-Wide Plan is $35,000, and under Ms. Ledger's LTIP is 
$140,000.

------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                             Target award                                Maximum award                               Actual award
                                                             -----------------------------------------------------------------------------------------------------------------------------------
                Incentive-based compensation                                         Value of    Total                           Value of    Total                           Value of    Total
                                                              Cash  ($)    Equity     equity     value    Cash  ($)    Equity     equity     value     Cash \1\    Equity     equity     value
                                                                            (#)        ($)        ($)                   (#)        ($)        ($)        ($)      \2\  (#)     ($)        ($)
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Annual Executive Plan.......................................     60,000      1,000     50,000    110,000     75,000      1,250     62,500    137,500     30,000      1,000     50,000     80,000
Annual Firm-Wide Plan.......................................     30,000  .........  .........     30,000     37,500  .........  .........     37,500     35,000  .........  .........     35,000
Ms. Ledger's LTIP...........................................     40,000      2,000    100,000    140,000     50,000      2,500    125,000    175,000     40,000      2,000    100,000    140,000
                                                             -----------------------------------------------------------------------------------------------------------------------------------

[[Page 37745]]

 
    Total Incentive-Based Compensation......................    130,000      3,000    150,000    280,000    162,500      3,750     87,500    350,000    105,000      3,000    150,000    255,000
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
\1\ The amount of actual cash award ABC chose to award.
\2\ The amount of actual equity award ABC chose to award.

    To calculate the minimum required deferred amounts, ABC would have 
to aggregate the amounts awarded under both the Annual Executive Plan 
($80,000) and the Annual Firm-Wide Plan ($35,000), because each has the 
same performance period, which is less than three years, to determine 
the total amount of qualifying incentive-based compensation awarded 
($115,000).\237\ At least 50 percent of that qualifying incentive-based 
compensation would be required to be deferred for at least three 
years.\238\ Thus, ABC would be required to defer cash and equity with 
an aggregate value of at least $57,500 from qualifying incentive-based 
compensation. ABC would have the flexibility to defer the amounts 
awarded in cash or in equity, as long as the total deferred incentive-
based compensation was composed of both substantial amounts of deferred 
cash and substantial amounts of deferred equity.\239\ ABC would also 
have the flexibility to defer amounts awarded from either the Annual 
Executive Plan or the Annual Firm-Wide Plan.
---------------------------------------------------------------------------

    \237\ See section __.7(a)(1) of the proposed rule.
    \238\ See sections __.7(a)(1)(i)(C) and __.7(a)(1)(ii)(B) of the 
proposed rule.
    \239\ See section __.7(a)(4)(i) of the proposed rule.
---------------------------------------------------------------------------

    In this example, ABC chooses to defer $27,500 of cash and 650 
shares from Ms. Ledger's award from the Annual Executive Plan, which 
has a total value of $60,000 at the time of the award, for three years 
and none of the award under the Annual Firm-Wide Plan.\240\
---------------------------------------------------------------------------

    \240\ Ms. Ledger's entire award under the Annual Firm-Wide Plan, 
$35,000, and remaining award under the Annual Executive Plan, $2,500 
and 350 shares, could vest immediately.

--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                 Total award                    Minimum required deferred                   Actual deferred
                                ------------------------------------------------------------------------------------------------------------------------
  Incentive-based compensation                          Value of    Total      Total                 Total                           Value of    Total
                                 Cash  ($)    Equity     equity     value      value     Deferral    value     Cash \2\    Equity     equity     value
                                               (#)        ($)        ($)        ($)     rate  (%)     ($)        ($)      \3\  (#)     ($)        ($)
--------------------------------------------------------------------------------------------------------------------------------------------------------
Annual Executive Plan..........     30,000      1,000     50,000     80,000  .........  .........  .........     27,500        650     32,500     60,000
Annual Firm-Wide Plan..........     35,000  .........  .........     35,000  .........  .........  .........  .........  .........  .........  .........
Qualified Incentive-Based           65,000      1,000     50,000    115,000    115,000         50     57,500     27,500        650     32,500     60,000
 Compensation..................
Ms. Ledger's LTIP..............     40,000      2,000    100,000    140,000    140,000         50     70,000     35,000        700     35,000     70,000
                                ------------------------------------------------------------------------------------------------------------------------
    Total Incentive-Based          105,000      3,000    150,000    255,000    255,000         50    127,500     62,500      1,350     67,500    130,000
     Compensation..............
--------------------------------------------------------------------------------------------------------------------------------------------------------
\1\ The aggregate amount from both the Annual Executive Plan and Annual Firm-Wide Plan.
\2\ The amount of actual cash award ABC chose to defer.
\3\ The amount of actual equity award ABC chose to defer.

Vesting Schedule

    ABC would have the flexibility to determine the schedule by which 
this deferred incentive-based compensation would be eligible for 
vesting, as long as the cumulative total of the deferred incentive-
based compensation that has been made eligible for vesting by any given 
year is not greater than the cumulative total that would have been 
eligible for vesting had the covered institution made equal amounts 
eligible for vesting each year.\241\ With deferred qualifying 
incentive-based compensation valued at $60,000 and three-year vesting, 
no more than $20,000 would be allowed to be eligible to vest on 
December 31, 2025, and no more than $40,000 would be eligible to vest 
on or before December 31, 2026. At least $20,000 would need to be 
eligible to vest on December 31, 2027, to be consistent with the 
proposed rule. In this example, ABC decides to make none of the 
deferred award from the Annual Executive Plan eligible for vesting on 
December 31, 2025; to make $13,750 and 325 shares (total value of cash 
and equity $30,000) eligible for vesting on December 31, 2026; and to 
make $13,750 and 325 shares (total value of cash and equity $30,000) 
eligible for vesting on December 31, 2027.
---------------------------------------------------------------------------

    \241\ See section __.7(a)(1)(iii) of the proposed rule.
---------------------------------------------------------------------------

    Ms. Ledger's LTIP has a performance period of three years, so Ms. 
Ledger's LTIP would meet the definition of a ``long-term incentive-
plan'' under the proposed rule.\242\ At least 50 percent of Ms. 
Ledger's LTIP amount ($140,000) would be required to be deferred for at 
least one year.\243\ Thus, ABC would be required to defer cash and 
equity with an aggregate value of at least $70,000 from Ms. Ledger's 
LTIP, which would be eligible for vesting on December 31, 2025. ABC 
would have flexibility to defer the amounts awarded in cash or in 
equity, as long as the total deferred incentive-based compensation were 
composed of both substantial amounts of deferred cash and substantial 
amounts of deferred equity.\244\ If ABC chooses to defer amounts 
awarded from Ms. Ledger's LTIP for longer than one year, ABC would have 
flexibility to determine the schedule on which it would be eligible for 
vesting, as long as the cumulative total of the deferred incentive-
based compensation that has been made eligible for vesting by any given 
year is not greater than the cumulative total that would have been 
eligible for vesting had the covered institution made equal amounts 
eligible for vesting in one year.\245\
---------------------------------------------------------------------------

    \242\ See the definition of ``long-term incentive plan'' in 
section __.2 of the proposed rule.
    \243\ See sections __.7(a)(2)(i)(C) and __.7(a)(2)(ii)(B) of the 
proposed rule.
    \244\ See section __.7(a)(4)(i) of the proposed rule.
    \245\ See section __.7(a)(2)(iii) of the proposed rule.
---------------------------------------------------------------------------

    In this example, ABC chooses to defer $35,000 of cash and 700 
shares of the award from Ms. Ledger's LTIP, which has a total value of 
$70,000 at the time of the award, for one year.\246\ The non-deferred 
amount ($35,000 and 700 shares) could vest at the time of the award on 
January 31, 2025.
---------------------------------------------------------------------------

    \246\ Ms. Ledger's remaining award under Ms. Ledger's LTIP would 
vest immediately.
---------------------------------------------------------------------------

    In summary, Ms. Ledger would receive $42,500 and 1,650 shares (a 
total value of $125,000) immediately after December 31, 2024.\247\ A 
total of $35,000 and 700 shares (total value $70,000) would be eligible 
to vest on

[[Page 37746]]

December 31, 2025. A total of $13,750 and 325 shares (total value 
$30,000) would be eligible to vest on December 31, 2026. Finally, a 
total of $13,750 and 325 shares (total value $30,000) would again be 
eligible to vest on December 31, 2027.
---------------------------------------------------------------------------

    \247\ This amount would represent $2,500 and 350 shares awarded 
under the Annual Executive Plan, $35,000 awarded under the Annual 
Firm-Wide Plan and $5,000 and 1,300 shares awarded under Ms. 
Ledger's LTIP.

--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                               Immediate amounts payable                            Total amounts deferred
                                                 -------------------------------------------------------------------------------------------------------
          Incentive-based compensation                                        Value of   Total value                              Value of   Total value
                                                    Cash ($)    Equity (#)   equity ($)      ($)        Cash ($)    Equity (#)   equity ($)      ($)
--------------------------------------------------------------------------------------------------------------------------------------------------------
Annual Executive Plan...........................       $2,500          350      $17,500      $20,000      $27,500          650      $32,500      $60,000
Annual Firm-Wide Plan...........................       35,000  ...........  ...........       35,000  ...........  ...........  ...........  ...........
Ms. Ledger's LTIP...............................        5,000        1,300       65,000       70,000       35,000          700       35,000       70,000
                                                 -------------------------------------------------------------------------------------------------------
    Total Incentive-Based Compensation..........       42,500        1,650       82,500      125,000       62,500        1,350       67,500      130,000
--------------------------------------------------------------------------------------------------------------------------------------------------------


                                                                                        Vesting Schedule
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                              12/31/2025                                  12/31/2026                                  12/31/2027
                                                             -----------------------------------------------------------------------------------------------------------------------------------
                Incentive-based compensation                                         Value of                                    Value of                                    Value of
                                                               Cash ($)    Equity     equity     Total     Cash ($)    Equity     equity     Total     Cash ($)    Equity     equity     Total
                                                                            (#)        ($)     value ($)                (#)        ($)     value ($)                (#)        ($)     value ($)
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Annual Executive Plan.......................................  .........  .........  .........  .........    $13,750        325    $16,250    $30,000    $13,750        325    $16,250    $30,000
Ms. Ledger's LTIP...........................................    $35,000        700    $35,000    $70,000  .........  .........  .........  .........  .........  .........  .........  .........
Amount Eligible for Vesting.................................  .........  .........  .........     70,000  .........  .........  .........     30,000  .........  .........  .........     30,000
Remaining Unvested Amount...................................  .........  .........  .........     60,000  .........  .........  .........     30,000  .........  .........  .........          0
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Use of Options in Deferred Incentive-Based Compensation

    If, under the total award amount outlined above, ABC chooses to 
award Ms. Ledger incentive-based compensation partially in the form of 
options, and chooses to defer the vesting of those options, no more 
than $38,250 worth of those options (the equivalent of 15 percent of 
the aggregate incentive-based compensation awarded to Ms. Ledger) would 
be eligible to be treated as deferred incentive-based 
compensation.\248\ As an example, ABC may award Ms. Ledger options that 
have a value at the end of the performance period of $10 and deferred 
vesting. ABC may choose to award Ms. Ledger incentive-based 
compensation with a total value of $255,000 in the following forms: 
$30,000 in cash, 640 shares of equity (valued at $32,000), and 1,800 
options (valued at $18,000) under the Annual Executive Plan; $35,000 
cash under the Annual Firm-Wide Plan; and $40,000 cash, 1,600 shares of 
equity (valued at $80,000), and 2,000 options (valued at $20,000) under 
Ms. Ledger's LTIP. Of that award, ABC may defer: $27,500 in cash, 290 
shares (valued at $14,500), and 1,800 options (valued at $18,000) under 
the Annual Executive Plan (total value of deferred $60,000); none of 
the award from the Annual Firm-Wide Plan; and $35,000 in cash, 300 
shares (valued at $15,000) and 2,000 options (valued at $20,000) under 
Ms. Ledger's LTIP (total value of deferred $70,000). The total value of 
options being counted as deferred incentive-based compensation would be 
$38,000, which would be 14.9 percent of the total incentive-based 
compensation awarded ($255,000). Assuming the vesting schedule is 
consistent with the proposed rule, Ms. Ledger's incentive-based 
compensation arrangement would be consistent with the proposed rule, 
because: (1) The value of Ms. Ledger's deferred incentive-based 
compensation under the Annual Executive Plan (which comprises all of 
Ms. Ledger's deferred qualifying incentive-based compensation) is more 
than 50 percent of the value of Ms. Ledger's total qualifying 
incentive-based compensation award ($115,000) and (2) the value of Ms. 
Ledger's deferred incentive-based compensation under Ms. Ledger's LTIP 
is 50 percent the value of Ms. Ledger's incentive-based compensation 
awarded under a long-term incentive plan ($140,000).
---------------------------------------------------------------------------

    \248\ See section __.7(a)(4)(ii).

                                       Alternative Scenario 1: Deferred Options Consistent With the Proposed Rule
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                Total award amounts
                                                         -----------------------------------------------------------------------------------------------
              Incentive-based compensation                                                   Value of                        Value of       Total value
                                                             Cash ($)       Equity (#)      equity ($)      Options (#)     options ($)         ($)
--------------------------------------------------------------------------------------------------------------------------------------------------------
Annual Executive Plan...................................         $30,000             640         $32,000           1,800         $18,000         $80,000
Annual Firm-Wide Plan...................................          35,000  ..............  ..............  ..............  ..............          35,000
Ms. Ledger's LTIP.......................................          40,000           1,600          80,000           2,000          20,000         140,000
                                                         -----------------------------------------------------------------------------------------------
    Total...............................................         105,000           2,240         112,000           3,800          38,000         255,000
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                            Amounts immediately payable
--------------------------------------------------------------------------------------------------------------------------------------------------------
Annual Executive Plan...................................          $2,500             350         $17,500  ..............  ..............          20,000
Annual Firm-Wide Plan...................................          35,000  ..............  ..............  ..............  ..............          35,000
Ms. Ledger's LTIP.......................................           5,000           1,300          65,000  ..............  ..............          70,000
                                                         -----------------------------------------------------------------------------------------------

[[Page 37747]]

 
    Total...............................................          42,500           1,650          82,500  ..............  ..............         125,000
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                              Total deferred amounts
--------------------------------------------------------------------------------------------------------------------------------------------------------
Annual Executive Plan...................................         $27,500             290         $14,500           1,800         $18,000         $60,000
Annual Firm-Wide Plan...................................  ..............  ..............  ..............  ..............  ..............  ..............
Ms. Ledger's LTIP.......................................          35,000             300          15,000           2,000          20,000          70,000
                                                         -----------------------------------------------------------------------------------------------
    Total...............................................          62,500             590          29,500           3,800          38,000         130,000
--------------------------------------------------------------------------------------------------------------------------------------------------------


------------------------------------------------------------------------
 
------------------------------------------------------------------------
Aggregate Incentive-Based Compensation Awarded.............     $255,000
Option Value at 15% Threshold Maximum......................       38,250
Minimum Qualifying Incentive-Based Compensation--Deferral         57,500
 at 50%....................................................
Minimum Incentive-Based Compensation Required under a Long-       70,000
 Term Incentive Plan--Deferral at 50%......................
------------------------------------------------------------------------

    In contrast, if ABC chooses to award Ms. Ledger more options than 
in the example above, Ms. Ledger's incentive-based compensation 
arrangement may no longer be consistent with the proposed rule. As a 
second alternative scenario, ABC may choose to award Ms. Ledger 
incentive-based compensation with a total value of $255,000 in the 
following forms: $30,000 In cash, 500 shares of equity (valued at 
$25,000), and 2,500 options (valued at $25,000) under the Annual 
Executive Plan; $35,000 cash under the Annual Firm-Wide Plan; and 
$40,000 cash, 1,600 shares of equity (valued at $80,000), and 2,000 
options (valued at $20,000) under Ms. Ledger's LTIP. Of that award, if 
ABC defers the following amounts, the arrangement would not be 
consistent with the proposed rule: $27,500 in cash, 150 shares (valued 
at $7,500), and 2,500 options (valued at $25,000) under the Annual 
Executive Plan (total value of deferred $60,000); none of the award 
from the Annual Firm-Wide Plan; and $35,000 in cash, 300 shares (valued 
at $15,000) and 2,000 options (valued at $20,000) under Ms. Ledger's 
LTIP (total value of deferred $70,000). The total value of options 
would be $45,000, which would be 17.6 percent of the total incentive-
based compensation awarded ($255,000). Thus, 675 of those options, or 
$6,750 worth, would not qualify to meet the minimum deferral 
requirements of the proposed rule. Combining qualifying incentive-based 
compensation and incentive-based compensation awarded under a long-term 
incentive plan, Ms. Ledger's total minimum required deferral amount 
would be $127,500, and yet incentive-based compensation worth only 
$123,250 would be eligible to meet the minimum deferral requirements. 
ABC could alter the proportions of incentive-based compensation awarded 
and deferred in order to comply with the proposed rule.

                                      Alternative Scenario 2: Deferred Options Inconsistent With the Proposed Rule
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                Total award amounts
                                                         -----------------------------------------------------------------------------------------------
              Incentive-based compensation                                                   Value of                        Value of       Total value
                                                             Cash ($)       Equity (#)      equity ($)      Options (#)     options ($)         ($)
--------------------------------------------------------------------------------------------------------------------------------------------------------
Annual Executive Plan...................................         $30,000             500         $25,000           2,500         $25,000         $80,000
Annual Firm-Wide Plan...................................          35,000  ..............  ..............  ..............  ..............          35,000
Ms. Ledger's LTIP.......................................          40,000           1,600          80,000           2,000          20,000         140,000
                                                         -----------------------------------------------------------------------------------------------
    Total...............................................         105,000           2,100         105,000           4,500          45,000         255,000
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                            Amounts immediately payable
--------------------------------------------------------------------------------------------------------------------------------------------------------
Annual Executive Plan...................................          $2,500             350         $17,500  ..............  ..............         $20,000
Annual Firm-Wide Plan...................................          35,000  ..............  ..............  ..............  ..............          35,000
Ms. Ledger's LTIP.......................................           5,000           1,300          65,000  ..............  ..............          70,000
                                                         -----------------------------------------------------------------------------------------------
    Total...............................................          42,500           1,650          82,500  ..............  ..............         125,000
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                              Total deferred amounts
--------------------------------------------------------------------------------------------------------------------------------------------------------
Annual Executive Plan...................................         $27,500             150          $7,500           2,500         $25,000         $60,000
Annual Firm-Wide Plan...................................  ..............  ..............  ..............  ..............  ..............  ..............
Ms. Ledger's LTIP.......................................          35,000             300          15,000           2,000          20,000          70,000
                                                         -----------------------------------------------------------------------------------------------
    Total...............................................          62,500             450          22,500           4,500          45,000         130,000
--------------------------------------------------------------------------------------------------------------------------------------------------------


[[Page 37748]]


------------------------------------------------------------------------
 
------------------------------------------------------------------------
Aggregate Incentive-Based Compensation Awarded.............     $255,000
Option Value at 15% Threshold Maximum......................       38,250
Non-Qualifying Options.....................................     6,750 or
                                                             675 options
Incentive-Based Compensation Eligible to Meet the Minimum        123,250
 Deferral Requirements.....................................
------------------------------------------------------------------------

Other Requirements Specific to Ms. Ledger's Incentive-Based 
Compensation Arrangement

    Under the proposed rule, ABC would not be allowed to accelerate the 
vesting of Ms. Ledger's deferred incentive-based compensation, except 
in the case of Ms. Ledger's death or disability, as determined by ABC 
pursuant to sections __.7(a)(1)(iii)(B) and __.7(a)(2)(iii)(B).
    Before vesting, ABC may determine to reduce the amount of deferred 
incentive-based compensation that Ms. Ledger receives pursuant to a 
forfeiture and downward adjustment review.\249\ If Ms. Ledger, or an 
employee Ms. Ledger managed, had been responsible for an event 
triggering the proposed rule's requirements for forfeiture and downward 
adjustment review, ABC would be expected to consider all of the 
unvested deferred amounts from the Annual Executive Plan and Ms. 
Ledger's LTIP for forfeiture before any incentive-based compensation 
vested even if the event occurred outside of the relevant performance 
period for the awards discussed in the example (i.e., January 1, 2022 
to December 31, 2024).\250\ ABC may also rely on other performance 
adjustments during the deferral period to appropriately balance Ms. 
Ledger's incentive-based compensation arrangement. In this case ABC 
would take into account information about Ms. Ledger's and ABC's 
performance that becomes better known during the deferral period to 
potentially reduce the amount of deferred incentive-based compensation 
that vests. ABC would not be allowed to increase the amount of deferred 
incentive-based compensation that vests. In the case of the deferred 
equity awarded to Ms. Ledger, the number of shares or options awarded 
to Ms. Ledger and eligible for vesting on each anniversary of the end 
of the performance period is the maximum number of shares or options 
that may vest on that date. An increase in the total value of those 
shares or options would not be considered an increase in the amount of 
deferred incentive-based compensation for the purposes of the proposed 
rule.\251\
---------------------------------------------------------------------------

    \249\ See ``Mr. Ticker: Forfeiture and downward adjustment 
review'' discussion below for more details about the requirements 
for a forfeiture and downward adjustment review.
    \250\ See section __.7(b) of the proposed rule.
    \251\ See section __.7(a)(3) of the proposed rule.
---------------------------------------------------------------------------

    ABC would be required to include clawback provisions in Ms. 
Ledger's incentive-based compensation arrangement that, at a minimum, 
allowed for clawback for seven years following the date on which Ms. 
Ledger's incentive-based compensation vested.\252\ These provisions 
would permit ABC to recover up to 100 percent of any vested incentive-
based compensation if ABC determined that Ms. Ledger engaged in certain 
misconduct, fraud or intentional misrepresentation of information, as 
described in section __.7(c) of the proposed rule. Thus, if in the year 
2030, ABC determined that Ms. Ledger engaged in fraud in the year 2024, 
the entirety of the $42,500 and 1,650 shares of equity that vested 
immediately after 2024, and as well as any part of her deferred 
incentive-based compensation ($62,500 and 1,350 shares of equity) that 
actually had vested by 2030, could be subject to clawback by ABC. Facts 
and circumstances would determine whether the ABC would actually seek 
to claw back amounts, as well as the specific amount ABC would seek to 
recover from Ms. Ledger's already-vested incentive-based compensation.
---------------------------------------------------------------------------

    \252\ See section __.7(c) of the proposed rule.
---------------------------------------------------------------------------

    Finally, in order for Ms. Ledger's incentive-based compensation 
arrangement to appropriately balance risk and reward, ABC would not be 
permitted to purchase a hedging instrument or similar instrument on Ms. 
Ledger's behalf that would offset any decrease in the value of Ms. 
Ledger's deferred incentive-based compensation.\253\
---------------------------------------------------------------------------

    \253\ See section __.8(a) of the proposed rule.
---------------------------------------------------------------------------

Risk Management and Controls and Governance

    Sections __.4(c)(2) and __.4(c)(3) of the proposed rule would 
require that Ms. Ledger's incentive-based compensation arrangement be 
compatible with effective risk management and controls and be supported 
by effective governance.
    For Ms. Ledger's arrangement to be compatible with effective risk 
management and controls, ABC's risk management framework and controls 
would be required to comply with the specific provisions of section 
__.9 of the proposed rule. ABC would have to maintain a risk management 
framework for its incentive-based compensation program that is 
independent of any lines of business, includes an independent 
compliance program, and is commensurate with the size and complexity of 
ABC's operations.\254\ ABC would have to provide individuals engaged in 
control functions with the authority to influence the risk-taking of 
the business areas they monitor and ensure that covered persons engaged 
in control functions are compensated in accordance with the achievement 
of performance objectives linked to their job functions, independent of 
the performance of those business areas.\255\ In addition, ABC would 
have to provide for independent monitoring of events related to 
forfeiture and downward adjustment reviews and decisions of forfeiture 
and downward adjustment reviews.\256\
---------------------------------------------------------------------------

    \254\ See section __.9(a) of the proposed rule.
    \255\ See section __.9(b) of the proposed rule.
    \256\ See section __.9(c) of the proposed rule.
---------------------------------------------------------------------------

    For Ms. Ledger's arrangement to be consistent with the effective 
governance requirement in the proposed rule, the board of directors of 
ABC would be required to establish a compensation committee composed 
solely of directors who are not senior executive officers. The board of 
directors, or a committee thereof, would be required to approve Ms. 
Ledger's incentive-based compensation arrangements, including the 
amounts of all awards and payouts under those arrangements.\257\ In 
this example, the board of directors or a committee thereof (such as 
the compensation committee) would be required to approve the total 
award of $105,000 and 3,000 shares in 2024. Each time deferred amounts 
are scheduled to vest (in this example, in December 31, 2025, December 
31, 2026, and December 31, 2027), the board of directors or a committee 
thereof would also be required to approve the amounts that vest.\258\ 
Additionally, the compensation committee would be required to receive 
input from the risk and audit committees of the ABC's board of 
directors on the effectiveness of risk measures and adjustments used to 
balance risk and reward in incentive-based compensation 
arrangements.\259\ Finally, the compensation committee would be 
required to obtain at least annually two written assessments, one 
prepared by ABC's management with input from the risk and audit 
committees of the board of directors and a separate assessment written 
from ABC's risk management or internal audit function developed 
independently of ABC's senior management. Both

[[Page 37749]]

assessments would focus on the effectiveness of ABC's incentive-based 
compensation program and related compliance and control processes in 
providing appropriate risk-taking incentives.\260\
---------------------------------------------------------------------------

    \257\ See section __.4(e) of the proposed rule.
    \258\ See sections __.4(e)(2) and __.4(e)(3) of the proposed 
rule.
    \259\ See section __.10(b)(1) of the proposed rule.
    \260\ See sections __.10(b)(2) and __.10(b)(3) of the proposed 
rule.
---------------------------------------------------------------------------

Recordkeeping

    In order to comply with the recordkeeping requirements in the 
proposed rule, ABC would be required to document Ms. Ledger's 
incentive-based compensation arrangement.\261\ ABC would be required to 
maintain copies of the Annual Executive Plan, the Annual Firm-Wide 
Plan, and Ms. Ledger's LTIP, along with all plans that are part of 
ABC's incentive-based compensation program. ABC also would be required 
to include Ms. Ledger on the list of senior executive officers and 
significant risk-takers, including the legal entity for which she 
works, her job function, her line of business, and her position in the 
organizational hierarchy.\262\ Finally, ABC would be required to 
document Ms. Ledger's entire incentive-based compensation arrangement, 
including information on percentage deferred and form of payment and 
any forfeiture and downward adjustment or clawback reviews and 
decisions that pertain to her.\263\
---------------------------------------------------------------------------

    \261\ See sections __.4(f) and __.5(a) of the proposed rule.
    \262\ See section __.5(a) of the proposed rule.
    \263\ See section __.5(a) of the proposed rule.
---------------------------------------------------------------------------

Mr. Ticker: Forfeiture and Downward Adjustment Review

    Under section __.7(b) of the proposed rule, ABC would be required 
to put certain portions of a senior executive officer's or significant 
risk-taker's incentive-based compensation at risk of forfeiture and 
downward adjustment upon certain triggering events.\264\ In this 
example, Mr. Ticker is a significant risk-taker who is the senior 
manager of a trader and a trading desk that engaged in inappropriate 
risk-taking in calendar year 2021, which was discovered on March 1, 
2024.\265\ The activity of the trader, and several other members of the 
same trading desk, resulted in an enforcement proceeding against ABC 
and the imposition of a significant fine.
---------------------------------------------------------------------------

    \264\ See section __.7(b) of the proposed rule.
    \265\ If Mr. Ticker's inappropriate risk-taking during 2021 were 
instead discovered in another year, ABC could subject all deferred 
amounts not yet vested in that year to forfeiture.
---------------------------------------------------------------------------

    Mr. Ticker is provided incentive-based compensation under two 
separate incentive-based compensation plans. The first plan, the 
``Annual Firm-Wide Plan,'' is applicable to all employees at ABC, and 
is based on a one-year performance period that coincides with the 
calendar year. The second plan, ``Mr. Ticker's LTIP,'' is applicable to 
all traders at Mr. Ticker's level, and requires assessment of 
performance over a three-year performance period that begins on January 
1, 2022 (year 1) and ends on December 31, 2024 (year 3). These two 
plans together comprise Mr. Ticker's incentive-based compensation 
arrangement.
    The proposed rule would require ABC to conduct a forfeiture and 
downward adjustment review both because the trades resulted from 
inappropriate risk-taking and because they failed to comply with a 
statutory, regulatory, or supervisory standard in a manner that 
resulted in an enforcement or legal action against ABC.\266\ In 
addition, the possibility exists that a material risk management and 
control failure as described in section __.7(b)(2)(iii) of the proposed 
rule has occurred, which would widen the group of covered employees 
whose incentive-based compensation would be considered for possible 
forfeiture and downward adjustment. Under the proposed rule, covered 
institutions would be required to consider forfeiture and downward 
adjustment for a covered person with direct responsibility for the 
adverse outcome (in this case, the trader, if designated as a 
significant risk-taker), as well as responsibility due to the covered 
person's role or position in the covered institution's organizational 
structure (in this case, Mr. Ticker for his possible lack of oversight 
of the trader when such activities were conducted).\267\
---------------------------------------------------------------------------

    \266\ See sections __.7(b)(2)(ii) and __.7(b)(2)(iv)(A) of the 
proposed rule.
    \267\ See section __.7(b)(3) of the proposed rule.
---------------------------------------------------------------------------

    In this example, ABC determines that as the senior manager of the 
trader, Mr. Ticker is responsible for inappropriate oversight of the 
trader and that Mr. Ticker facilitated the inappropriate risk-taking 
the trader engaged in. Under the proposed rule, ABC would have to 
consider all of Mr. Ticker's unvested deferred incentive-based 
compensation, including unvested deferred amounts awarded under Mr. 
Ticker's LTIP, when determining the appropriate impact on Mr. Ticker's 
incentive-based compensation.\268\ In addition, all of Mr. Ticker's 
incentive-based compensation amounts not yet awarded for the current 
performance period, including amounts to be awarded under Mr. Ticker's 
LTIP, would have to be considered for possible downward 
adjustment.\269\ The amount by which Mr. Ticker's incentive-based 
compensation would be reduced could be part or all of the relevant 
tranches which have not yet vested or have not yet been awarded. For 
example, if Mr. Ticker's lack of oversight were determined to be only a 
contributing factor that led to the adverse outcome (e.g., Mr. Ticker 
identified and elevated the breach of related risk limits but made no 
effort to follow up in order to ensure that such activity immediately 
ceased), ABC might be comfortable reducing only a portion of the 
incentive-based compensation to be awarded under Mr. Ticker's LTIP in 
2024.
---------------------------------------------------------------------------

    \268\ See section __.7(b)(1)(i) of the proposed rule.
    \269\ See section __.7(b)(1)(ii) of the proposed rule.
---------------------------------------------------------------------------

    To determine the amount or portion of Mr. Ticker's incentive-based 
compensation that should be forfeited or adjusted downward under the 
proposed rule, ABC would be required to consider, at a minimum, the six 
factors listed in section __.7(b)(4) of the proposed rule.\270\ The 
cumulative impact of these factors, when appropriately weighed in the 
final decision-making process, might lead to lesser or greater impact 
on Mr. Ticker's incentive-based compensation. For instance, if it were 
found that Mr. Ticker had repeatedly failed to manage traders or others 
who report to him, ABC might decide that a reduction of 100 percent of 
Mr. Ticker's incentive-based compensation at risk would be 
appropriate.\271\ On the other hand, if it were determined that Mr. 
Ticker took immediate and meaningful actions to prevent the adverse 
outcome from occurring and immediately escalated and addressed the 
inappropriate behavior, the impact on Mr. Ticker's incentive-based 
compensation could be less than 100 percent, or nothing.
---------------------------------------------------------------------------

    \270\ See section __.7(b)(4) of the proposed rule.
    \271\ See sections __.7(b)(4)(ii) and (iii) of the proposed 
rule.
---------------------------------------------------------------------------

    It is possible that some or all of Mr. Ticker's incentive-based 
compensation may be forfeited before it vests, which could result in 
amounts vesting faster than pro rata. In this case, ABC decides to 
defer $30,000 of Mr. Ticker's incentive-based compensation for three 
years so that $10,000 is eligible for vesting in 2022, $10,000 is 
eligible for vesting in 2023, and $10,000 is eligible for vesting in 
2024. This schedule would meet the proposed rule's pro rata vesting 
requirement. No adverse information about Mr. Ticker's performance 
comes to light in 2022 or 2023 and so $10,000 vests in each of those 
years. However, Mr. Ticker's

[[Page 37750]]

inappropriate risk-taking during 2021 is discovered in 2024, causing 
ABC to forfeit the remaining $10,000. Therefore, the amounts that vest 
in this case are $10,000 in 2022, $10,000 in 2023, and $0 in 2024. 
While the vesting is faster than pro rata due to the forfeiture, the 
incentive-based compensation arrangement would still be consistent with 
the proposed rule since the original vesting schedule would have been 
in compliance.
    ABC would be required to document the rationale for its decision 
and to keep timely and accurate records that detail the individuals 
considered for compensation adjustments, the factors weighed in 
reaching a final decision and how those factors were considered during 
the decision-making process.\272\
---------------------------------------------------------------------------

    \272\ See section __.5(a)(3) of the proposed rule.
---------------------------------------------------------------------------

IV. Request for Comments

    The Agencies are interested in receiving comments on all aspects of 
the proposed rule.

V. Regulatory Analysis

A. Regulatory Flexibility Act

    OCC: Pursuant to section 605(b) of the Regulatory Flexibility Act, 
5 U.S.C. 605(b) (``RFA''), the initial regulatory flexibility analysis 
otherwise required under section 603 of the RFA is not required if the 
agency certifies that the proposed rule will not, if promulgated, have 
a significant economic impact on a substantial number of small entities 
(defined for purposes of the RFA to include banks and Federal branches 
and agencies with assets less than or equal to $550 million) and 
publishes its certification and a short, explanatory statement in the 
Federal Register along with its proposed rule.
    As discussed in the SUPPLEMENTARY INFORMATION section above, 
section 956 of the Dodd-Frank Act does not apply to institutions with 
assets of less than $1 billion. As a result, the proposed rule will 
not, if promulgated, apply to any OCC-supervised small entities. For 
this reason, the proposed rule will not, if promulgated, have a 
significant economic impact on a substantial number of OCC-supervised 
small entities. Therefore, the OCC certifies that the proposed rule 
will not, if promulgated, have a significant economic impact on a 
substantial number of small entities.
    Board: The Board has considered the potential impact of the 
proposed rule on small banking organizations in accordance with the RFA 
(5 U.S.C. 603(b)). As discussed in the SUPPLEMENTARY INFORMATION above, 
section 956 of the Dodd-Frank Act (codified at 12 U.S.C. 5641) requires 
that the Agencies prohibit any incentive-based payment arrangement, or 
any feature of any such arrangement, at a covered financial institution 
that the Agencies determine encourages inappropriate risks by a 
financial institution by providing excessive compensation or that could 
lead to material financial loss. In addition, under the Dodd-Frank Act 
a covered financial institution also must disclose to its appropriate 
Federal regulator the structure of its incentive-based compensation 
arrangements. The Board and the other Agencies have issued the proposed 
rule in response to these requirements of the Dodd-Frank Act.
    The proposed rule would apply to ``covered institutions'' as 
defined in the proposed rule. Covered institutions as so defined 
include specifically listed types of institutions, as well as other 
institutions added by the Agencies acting jointly by rule. In every 
case, however, covered institutions must have at least $1 billion in 
total consolidated assets pursuant to section 956(f). Thus the proposed 
rule is not expected to apply to any small banking organizations 
(defined as banking organizations with $550 million or less in total 
assets). See 13 CFR 121.201.
    The proposed rule would implement section 956(a) of the Dodd-Frank 
act by requiring a covered institution to create annually and maintain 
for a period of at least seven years records that document the 
structure of all its incentive-based compensation arrangements and 
demonstrate compliance with the proposed rule. A covered institution 
must disclose the records to the Board upon request. At a minimum, the 
records must include copies of all incentive-based compensation plans, 
a record of who is subject to each plan, and a description of how the 
incentive-based compensation program is compatible with effective risk 
management and controls.
    Covered institutions with at least $50 billion in consolidated 
assets, and their subsidiaries with at least $1 billion in total 
consolidated assets, would be subject to additional, more specific 
requirements, including that such covered institutions create annually 
and maintain for a period of at least seven years records that 
document: (1) The covered institution's senior executive officers and 
significant risk-takers, listed by legal entity, job function, 
organizational hierarchy, and line of business; (2) the incentive-based 
compensation arrangements for senior executive officers and significant 
risk-takers, including information on percentage of incentive-based 
compensation deferred and form of award; (3) any forfeiture and 
downward adjustment or clawback reviews and decisions for senior 
executive officers and significant risk-takers; and (4) any material 
changes to the covered institution's incentive-based compensation 
arrangements and policies. These larger covered institutions must 
provide these records in such form and with such frequency as requested 
by the Board, and they must be maintained in a manner that allows for 
an independent audit of incentive-based compensation arrangements, 
policies, and procedures.
    As described above, the volume and detail of information required 
to be created and maintained by a covered institution is tiered; 
covered institutions with less than $50 billion in total consolidated 
assets are subject to less rigorous and detailed informational 
requirements than larger covered institutions. As such, the Board 
expects that the volume and detail of information created and 
maintained by a covered institution with greater than $50 billion in 
consolidated assets, that may use incentive-based arrangements to a 
significant degree, would be substantially greater than that created 
and maintained by a smaller institution.
    The proposed rule would implement section 956(b) of the Dodd-Frank 
Act by prohibiting a covered institution from having incentive-based 
compensation arrangements that may encourage inappropriate risks (i) by 
providing excessive compensation or (ii) that could lead to material 
financial loss. The proposed rule would establish standards for 
determining whether an incentive-based compensation arrangement 
violates these prohibitions. These standards would include deferral, 
forfeiture, downward adjustment, clawback, and other requirements for 
certain covered persons at covered institutions with total consolidated 
assets of more than $50 billion, and their subsidiaries with at least 
$1 billion in assets, as well as specific prohibitions on incentive-
based compensation arrangements at these institutions. Consistent with 
section 956(c), the standards adopted under section 956 are comparable 
to the compensation-related safety and soundness standards applicable 
to insured depository institutions under section 39 of the FDIA. The 
proposed rule also would supplement existing guidance adopted by the 
Board and the other Federal Banking Agencies regarding incentive-based 
compensation (i.e., the 2010 Federal Banking Agency Guidance, as

[[Page 37751]]

defined in the SUPPLEMENTARY INFORMATION above).
    The proposed rule also would require all covered institutions to 
have incentive-based compensation arrangements that are compatible with 
effective risk management and controls and supported by effective 
governance. In addition, the board of directors, or a committee 
thereof, of a covered institution to conduct oversight of the covered 
institution's incentive-based compensation program and to approve 
incentive-based compensation arrangements and material exceptions or 
adjustments to incentive-based compensation policies or arrangements 
for senior executive officers. For covered institutions with greater 
than $50 billion in total consolidated assets, and their subsidiaries 
with at least $1 billion in total consolidated assets, the proposed 
rule includes additional specific requirements for risk management and 
controls, governance and policies and procedures. Thus, like the 
deferral, forfeiture, downward adjustment, clawback and other 
requirements referred to above, risk management, governance, and 
policies and procedures requirements are tiered based on the size of 
the covered institution, with smaller institutions only subject to 
general risk management, controls, and governance requirements and 
larger institutions subject to more detailed requirements, including 
policies and procedures requirements. Therefore, the requirements of 
the proposed rule in these areas would be expected to be less extensive 
for covered institutions with less than $50 billion in total 
consolidated assets than for larger covered institutions.
    As noted above, because the proposed rule applies to institutions 
that have at least $1 billion in total consolidated assets, if adopted 
in final form it is not expected to apply to any small banking 
organizations for purposes of the RFA. In light of the foregoing, the 
Board does not believe that the proposed rule, if adopted in final 
form, would have a significant economic impact on a substantial number 
of small entities supervised by the Board. The Board specifically seeks 
comment on whether the proposed rule would impose undue burdens on, or 
have unintended consequences for, small institutions and whether there 
are ways such potential burdens or consequences could be addressed in a 
manner consistent with section 956 of the Dodd-Frank Act.
    FDIC: In accordance with the RFA, 5 U.S.C. 601-612 (``RFA''), an 
agency must provide an initial regulatory flexibility analysis with a 
proposed rule or to certify that the rule will not have a significant 
economic impact on a substantial number of small entities (defined for 
purposes of the RFA to include banking entities with total assets of 
$550 million or less).
    As described in the Scope and Initial Applicability section of the 
SUPPLEMENTARY INFORMATION above, the proposed rule would establish 
general requirements applicable to the incentive-based compensation 
arrangements of all institutions defined as covered institutions under 
the proposed rule (i.e., covered institutions with average total 
consolidated assets of $1 billion or more that offers incentive-based 
compensation to covered persons). As of December 31, 2015, a total of 
353 FDIC-supervised institutions had total assets of $1 billion or more 
and would be subject to the proposed rule.
    As of December 31, 2015, there were 3,947 FDIC-supervised 
depository institutions. Of those depository institutions, 3,262 had 
total assets of $550 million or less. All FDIC-supervised depository 
institutions that fall under the $550 million asset threshold, by 
definition, would not be subject to the proposed rule, regardless of 
their incentive-based compensation practices.
    Therefore, the FDIC certifies that the notice of proposed 
rulemaking would not have a significant economic impact on a 
substantial number of small FDIC-supervised institutions.
    FHFA: FHFA believes that the proposed rule will not have a 
significant economic impact on a substantial number of small entities, 
since none of FHFA's regulated entities come within the meaning of 
small entities as defined in the RFA (see 5 U.S.C. 601(6)), and the 
proposed rule will not substantially affect any business that its 
regulated entities might conduct with such small entities.
    NCUA: The RFA requires NCUA to prepare an analysis to describe any 
significant economic impact a regulation may have on a substantial 
number of small entities.\273\ For purposes of this analysis, NCUA 
considers small credit unions to be those having under $100 million in 
assets.\274\ Section 956 of the Dodd Frank Act and the NCUA's proposed 
rule apply only to credit unions with $1 billion or more in assets. 
Accordingly, NCUA certifies that the proposed rule would not have a 
significant economic impact on a substantial number of small entities 
since the credit unions subject to NCUA's proposed rule are not small 
entities for RFA purposes.
---------------------------------------------------------------------------

    \273\ 5 U.S.C. 603(a).
    \274\ 80 FR 57512 (September 24, 2015).
---------------------------------------------------------------------------

    SEC: Pursuant to 5 U.S.C. 605(b), the SEC hereby certifies that the 
proposed rules would not, if adopted, have a significant economic 
impact on a substantial number of small entities. The SEC notes that 
the proposed rules would not apply to broker-dealers or investment 
advisers with less than $1 billion in total consolidated assets. 
Therefore, the SEC believes that all broker-dealers and investment 
advisers that are likely to be covered institutions under the proposed 
rules would not be small entities.
    The SEC encourages written comments regarding this certification. 
The SEC solicits comment as to whether the proposed rules could have an 
effect on small entities that has not been considered. The SEC requests 
that commenters describe the nature of any impact on small entities and 
provide empirical data to support the extent of such impact.

B. Paperwork Reduction Act

    Certain provisions of the proposed rule contain ``collection of 
information'' requirements within the meaning of the Paperwork 
Reduction Act (PRA) of 1995.\275\ In accordance with the requirements 
of the PRA, the Agencies may not conduct or sponsor, and a respondent 
is not required to respond to, an information collection unless it 
displays a currently valid Office of Management and Budget (OMB) 
control number. The information collection requirements contained in 
this joint notice of proposed rulemaking have been submitted by the 
OCC, FDIC, NCUA, and SEC to OMB for review and approval under section 
3506 of the PRA and section 1320.11 of OMB's implementing regulations 
(5 CFR part 1320). The Board reviewed the proposed rule under the 
authority delegated to the Board by OMB. FHFA has found that, with 
respect to any regulated entity as defined in section 1303(20) of the 
Safety and Soundness Act (12 U.S.C. 4502(20)), the proposed rule does 
not contain any collection of information that requires the approval of 
the OMB under the PRA. The recordkeeping requirements are found in 
sections __.4(f), __.5, and __.11.
---------------------------------------------------------------------------

    \275\ 44 U.S.C. 3501-3521.
---------------------------------------------------------------------------

    Comments are invited on:
    (a) Whether the collections of information are necessary for the 
proper performance of the Agencies' functions, including whether the 
information has practical utility;
    (b) The accuracy of the estimates of the burden of the information

[[Page 37752]]

collections, including the validity of the methodology and assumptions 
used;
    (c) Ways to enhance the quality, utility, and clarity of the 
information to be collected;
    (d) Ways to minimize the burden of the information collections on 
respondents, including through the use of automated collection 
techniques or other forms of information technology; and
    (e) Estimates of capital or start up costs and costs of operation, 
maintenance, and purchase of services to provide information.
    All comments will become a matter of public record. Comments on 
aspects of this notice that may affect reporting, recordkeeping, or 
disclosure requirements and burden estimates should be sent to the 
addresses listed in the ADDRESSES section. A copy of the comments may 
also be submitted to the OMB desk officer for the Agencies by mail to 
U.S. Office of Management and Budget, 725 17th Street NW., #10235, 
Washington, DC 20503, by facsimile to (202) 395-5806, or by email to 
[email protected], Attention, Commission and Federal Banking 
Agency Desk Officer.
Proposed Information Collection
    Title of Information Collection: Recordkeeping Requirements 
Associated with Incentive-Based Compensation Arrangements.
    Frequency of Response: Annual.
    Affected Public: Businesses or other for-profit.
    Respondents:
    OCC: National banks, Federal savings associations, and Federal 
branches or agencies of a foreign bank with average total consolidated 
assets greater than or equal to $1 billion and their subsidiaries.
    Board: State member banks, bank holding companies, savings and loan 
holding companies, Edge and Agreement corporations, state-licensed 
uninsured branches or agencies of a foreign bank, and foreign banking 
organization with average total consolidated assets greater than or 
equal to $1 billion and their subsidiaries.
    FDIC: State nonmember banks, state savings associations, and state 
insured branches of a foreign bank, and certain subsidiaries thereof, 
with average total consolidated assets greater than or equal to $1 
billion.
    NCUA: Credit unions with average total consolidated assets greater 
than or equal to $1 billion.
    SEC: Brokers or dealers registered under section 15 of the 
Securities Exchange Act of 1934 and investment advisers as such term is 
defined in section 202(a)(11) of the Investment Advisers Act of 1940, 
in each case, with average total consolidated assets greater than or 
equal to $1 billion.
    Abstract: Section 956(e) of the Dodd-Frank Act requires that the 
Agencies prohibit incentive-based payment arrangements at a covered 
financial institution that encourage inappropriate risks by a financial 
institution by providing excessive compensation or that could lead to 
material financial loss. Under the Dodd-Frank Act, a covered financial 
institution also must disclose to its appropriate Federal regulator the 
structure of its incentive-based compensation arrangements sufficient 
to determine whether the structure provides ``excessive compensation, 
fees, or benefits'' or ``could lead to material financial loss'' to the 
institution. The Dodd-Frank Act does not require a covered financial 
institution to disclose compensation of individuals as part of this 
requirement.
    Section __.4(f) would require all covered institutions to create 
annually and maintain for a period of at least seven years records that 
document the structure of all its incentive-based compensation 
arrangements and demonstrate compliance with this part. A covered 
institution must disclose the records to the Agency upon request. At a 
minimum, the records must include copies of all incentive-based 
compensation plans, a record of who is subject to each plan, and a 
description of how the incentive-based compensation program is 
compatible with effective risk management and controls.
    Section __.5 would require a Level 1 or Level 2 covered institution 
to create annually and maintain for a period of at least seven years 
records that document: (1) The covered institution's senior executive 
officers and significant risk-takers, listed by legal entity, job 
function, organizational hierarchy, and line of business; (2) the 
incentive-based compensation arrangements for senior executive officers 
and significant risk-takers, including information on percentage of 
incentive-based compensation deferred and form of award; (3) any 
forfeiture and downward adjustment or clawback reviews and decisions 
for senior executive officers and significant risk-takers; and (4) any 
material changes to the covered institution's incentive-based 
compensation arrangements and policies. A Level 1 or Level 2 covered 
institution must create and maintain records in a manner that allows 
for an independent audit of incentive-based compensation arrangements, 
policies, and procedures, including, those required under Sec.  __.11. 
A Level 1 or Level 2 covered institution must provide the records 
described above to the Agency in such form and with such frequency as 
requested by Agency.
    Section __.11 would require a Level 1 or Level 2 covered 
institution to develop and implement policies and procedures for its 
incentive-based compensation program that, at a minimum (1) are 
consistent with the prohibitions and requirements of this part; (2) 
specify the substantive and procedural criteria for the application of 
forfeiture and clawback, including the process for determining the 
amount of incentive-based compensation to be clawed back; (3) require 
that the covered institution maintain documentation of final 
forfeiture, downward adjustment, and clawback decisions; (4) specify 
the substantive and procedural criteria for the acceleration of 
payments of deferred incentive-based compensation to a covered person, 
consistent with section __.7(a)(1)(iii)(B) and section 
__.7(a)(2)(iii)(B)); (5) identify and describe the role of any 
employees, committees, or groups authorized to make incentive-based 
compensation decisions, including when discretion is authorized; (6) 
describe how discretion is expected to be exercised to appropriately 
balance risk and reward; (7) require that the covered institution 
maintain documentation of the establishment, implementation, 
modification, and monitoring of incentive-based compensation 
arrangements, sufficient to support the covered institution's 
decisions; (8) describe how incentive-based compensation arrangements 
will be monitored; (9) specify the substantive and procedural 
requirements of the independent compliance program consistent with 
section 9(a)(2); and (10) ensure appropriate roles for risk management, 
risk oversight, and other control function personnel in the covered 
institution's processes for designing incentive-based compensation 
arrangements and determining awards, deferral amounts, deferral 
periods, forfeiture, downward adjustment, clawback, and vesting; and 
assessing the effectiveness of incentive-based compensation 
arrangements in restraining inappropriate risk-taking.
Collection of Information Is Mandatory
    The collection of information will be mandatory for any covered 
institution subject to the proposed rules.
Confidentiality
    The information collected pursuant to the collection of information 
will be

[[Page 37753]]

kept confidential, subject to the provisions of applicable law.
Estimated Paperwork Burden
    In determining the method for estimating the paperwork burden the 
Board, OCC and FDIC made the assumption that covered institution 
subsidiaries of a covered institution subject to the Board's, OCC's or 
FDIC's proposed rule, respectively, would act in concert with one 
another to take advantage of efficiencies that may exist. The Board, 
OCC and FDIC invite comment on whether it is reasonable to assume that 
covered institutions that are affiliated entities would act jointly or 
whether they would act independently to implement programs tailored to 
each entity.
Estimated Average Hours per Response
    Recordkeeping Burden
    Sec.  __.4(f)-20 hours (Initial setup 40 hours).
    Sec. Sec.  __.5 and __.11 (Level 1 and Level 2)-20 hours (Initial 
setup 40 hours).
OCC
    Number of respondents: 229 (Level 1-18, Level 2-17, and Level 3-
194).
    Total estimated annual burden: 15,840 hours (10,560 hours for 
initial setup and 5,280 hours for ongoing compliance).
Board
    Number of respondents: 829 (Level 1-15, Level 2-51, and Level 3-
763).
    Total estimated annual burden: 53,700 hours (35,800 hours for 
initial setup and 17,900 hours for ongoing compliance).
FDIC
    Number of respondents: 353 (Level 1-0, Level 2-13, and Level 3-
340).
    Total estimated annual burden: 21,960 hours (14,640 hours for 
initial setup and 7,320 hours for ongoing compliance).
NCUA
    Number of respondents: 258 (Level 1-0, Level 2-1, and Level 3-257).
    Total estimated annual burden: 15,540 hours (10,360 hours for 
initial setup and 5,180 hours for ongoing compliance).
SEC
    Number of respondents: 806 (Level 1-58, Level 2-36, and Level 3-
712).
    Total estimated annual burden: 54,000 hours (36,000 hours for 
initial setup and 18,000 hours for ongoing compliance)
    Amendments to Exchange Act Rule 17a-4 and Investment Advisers Act 
Rule 204-2: The proposed amendments to Exchange Act Rule 17a-4 and 
Investment Advisers Act Rule 204-2 contain ``collection of information 
requirements'' within the meaning of the PRA. The SEC has submitted the 
collections of information to OMB for review in accordance with 44 
U.S.C. 3507 and 5 CFR 1320.11. An agency may not conduct or sponsor, 
and a person is not required to respond to, a collection of information 
unless it displays a currently valid OMB control number. OMB has 
assigned control number 3235-0279 to Exchange Act Rule 17a-4 and 
control number 3235-0278 to Investment Advisers Act Rule 204-2. The 
titles of these collections of information are ``Rule 17a-4; Records to 
be Preserved by Certain Exchange Members, Brokers and Dealers'' and 
``Rule 204-2 under the Investment Advisers Act of 1940.'' The 
collections of information required by the proposed amendments to 
Exchange Act Rule 17a-4 and Investment Advisers Act Rule 204-2 will be 
necessary for any broker-dealer or investment adviser (registered or 
required to be registered under section 203 of the Investment Advisers 
Act (15 U.S.C. 80b-3)) (``covered investment advisers''), as 
applicable, that is a covered institution subject to the proposed 
rules.
A. Summary of Collection of Information
    The SEC is proposing amendments to Exchange Act Rule 17a-4(e) (17 
CFR 240.17a-4(e)) and Investment Advisers Act Rule 204-2 (17 CFR 
275.204-2) to require that broker-dealers and covered investment 
advisers that are covered institutions maintain the records required by 
Sec.  __.4(f), and for broker-dealers or covered investment advisers 
that are Level 1 or Level 2 covered institutions, Sec. Sec.  __.5 and 
__.11, in accordance with the recordkeeping requirements of Exchange 
Act Rule 17a-4 or Investment Advisers Act Rule 204-2, as applicable.
B. Proposed Use of Information
    The collections of information are necessary for, and will be used 
by, the SEC to determine compliance with the proposed rules and section 
956 of the Dodd-Frank Act. Exchange Act Rule 17a-4 requires a broker-
dealer to preserve records if the broker-dealer makes or receives the 
type of record and establishes the general formatting and storage 
requirements for records that broker-dealers are required to keep. 
Investment Advisers Act Rule 204-2 establishes general recordkeeping 
requirements for covered investment advisers. For the sake of 
consistency with other broker-dealer or covered investment adviser 
records, the SEC believes that broker-dealers and covered investment 
advisers that are covered institutions should also keep the records 
required by Sec.  __.4(f), and for broker-dealers or covered investment 
advisers that are Level 1 or Level 2 covered institutions, Sec. Sec.  
__.5 and __.11, in accordance with these requirements.
C. Respondents
    The collections of information will apply to any broker-dealer or 
covered investment adviser that is a covered institution under the 
proposed rules. The SEC estimates that 131 broker-dealers and 
approximately 669 investment advisers will be covered institutions 
under the proposed rules. The SEC further estimates that of those 131 
broker-dealers, 49 will be Level 1 or Level 2 covered institutions, and 
82 will be Level 3 covered institutions and that of those 669 
investment advisers, approximately 18 will be Level 1 covered 
institutions, approximately 21 will be Level 2 covered institutions, 
and approximately 630 will be Level 3 covered institutions.\276\
---------------------------------------------------------------------------

    \276\ For a discussion of how the SEC arrived at these 
estimates, see the SEC Economic Analysis at Section V.I.
---------------------------------------------------------------------------

D. Total Annual Reporting and Recordkeeping Burden
    The collection of information would add three types of records to 
be maintained and preserved by broker-dealers and covered investment 
advisers: The records required by Sec.  __.4(f), and for broker-dealers 
or covered investment advisers that are Level 1 or Level 2 covered 
institutions, the records required by Sec.  __.5 and the policies and 
procedures required by Sec.  __.11.
1. Exchange Act Rule 17a-4
    In recent proposed amendments to Exchange Act Rule 17a-4, the SEC 
estimated that proposed amendments adding three types of records to be 
preserved by broker-dealers pursuant to Exchange Act Rule 17a-4(b) 
would impose an initial burden of 39 hours per broker-dealer and an 
ongoing annual burden of 18 hours and $360 per broker-dealer.\277\ The 
SEC believes that those

[[Page 37754]]

estimates provide a reasonable estimate for the burden imposed by the 
collection of information because the collection of information would 
add three types of records to be preserved by broker-dealers pursuant 
to Exchange Act Rule 17a-4(e). The records required to be preserved 
under Exchange Act Rule 17a-4(e) are subject to the similar formatting 
and storage requirements as the records required to be preserved under 
Exchange Act Rule 17a-4(b). For example, paragraph (f) of Exchange Act 
Rule 17a-4 provides that the records a broker-dealer is required to 
maintain and preserve under Exchange Act Rule 17a-4, including those 
under paragraph (b) and (e), may be immediately produced or reproduced 
on micrographic media or by means of electronic storage media. 
Similarly, paragraph (j) of Exchange Act Rule 17a-4 requires a broker-
dealer to furnish promptly to a representative of the SEC legible, 
true, complete, and current copies of those records of the broker-
dealer that are required to be preserved under Exchange Act Rule 17a-4, 
including those under paragraph (b) and (e).
---------------------------------------------------------------------------

    \277\ Recordkeeping and Reporting Requirements for Security-
Based Swap Dealers, Major Security-Based Swap Participants, and 
Broker-Dealers; Capital Rule for Certain Security-Based Swap 
Dealers, Release No. 34-71958 (Apr. 17, 2014), 79 FR 25194, 25267 
(May 2, 2014). The burden hours estimated by the SEC for amending 
Exchange Act Rule 17a-4(b) include burdens attributable to ensuring 
adequate physical space and computer hardware and software storage 
for the records and promptly producing them when requested. These 
burdens may include, as necessary, acquiring additional physical 
space, computer hardware, and software storage and establishing and 
maintaining additional systems for computer software and hardware 
storage.
---------------------------------------------------------------------------

    The SEC notes, however, that paragraph (b) of Exchange Act Rule 
17a-4 includes a three-year minimum retention period while paragraph 
(e) does not include any retention period. Thus, to the extent that a 
portion of the SEC's previously estimated burdens with respect to the 
amendments to Exchange Act Rule 17a-4(b) represent the burden of 
complying with the minimum retention period, using those same burden 
estimates with respect to the collection of information may represent a 
slight overestimate because the collection of information does not 
include a minimum retention period. The SEC believes, however, that the 
previously estimated burdens with respect to the amendments to Exchange 
Act Rule 17a-4(b) represent a reasonable estimate of the burdens of the 
collection of information given the other similarities between Exchange 
Act Rule 17a-4(b) and Exchange Act Rule 17a-4(e) discussed above. 
Moreover, the burden to create, and the retention period for, the 
records required by Sec.  __.4(f), and for Level 1 and Level 2 broker-
dealers, the records required by Sec.  __.5 and the policies and 
procedures required by Sec.  __.11, is accounted for in the PRA 
estimates for the proposed rules. Consequently, the burdens imposed by 
the collection of information are to ensure adequate physical space and 
computer hardware and software storage for the records and promptly 
produce them when requested.\278\
---------------------------------------------------------------------------

    \278\ As discussed above, paragraph (j) of Exchange Act Rule 
17a-4 requires a broker-dealer to furnish promptly to a 
representative of the SEC legible, true, complete, and current 
copies of those records of the broker-dealer that are required to be 
preserved under Exchange Act Rule 17a-4. Thus, the SEC estimates 
that this promptness requirement will be part of the incremental 
burden of the collection of information.
---------------------------------------------------------------------------

    Therefore, the SEC estimates that each of the three types of 
records required to be preserved pursuant to the collection of 
information will each impose an initial burden of 13 hours \279\ per 
respondent and an ongoing annual burden of 6 hours \280\ and $120 \281\ 
per respondent. This is the result of dividing the SEC's previously 
estimated burdens with respect to the amendments to Exchange Act Rule 
17a-4(b) by three to produce a per-record burden estimate.
---------------------------------------------------------------------------

    \279\ 13 hours is the result of dividing the SEC's previously 
estimated burdens with respect to the amendments to Exchange Act 
Rule 17a-4(b) (39 hours) by three to produce a per-record burden 
estimate. 39 hours/3 types of records = 13 hours per record. These 
internal hours likely will be performed by a senior database 
administrator.
    \280\ 6 hours is the result of dividing the SEC's previously 
estimated burdens with respect to the amendments to Exchange Act 
Rule 17a-4(b) (18 hours) by three to produce a per-record burden 
estimate. 18 hours/3 types of records = 6 hours per record. These 
internal hours likely will be performed by a compliance clerk.
    \281\ $120 is the result of dividing the SEC's previously 
estimated cost with respect to the amendments to Exchange Act Rule 
17a-4(b) ($360) by three to produce a per-record cost estimate. $360 
hours/3 types of records = $120 per record.
---------------------------------------------------------------------------

    The SEC estimates that requiring broker-dealers to maintain the 
records required by Sec.  __.4(f) in accordance with Exchange Act Rule 
17a-4 will impose an initial burden of 13 hours per respondent and a 
total ongoing annual burden of 6 hours and $120 per respondent. The 
total burden for all respondents will be 1,703 hours initially (13 
hours x 131 Level 1, Level 2, and Level 3 broker-dealers) and 786 hours 
annually (6 hours x 131 Level 1, Level 2, and Level 3 broker-dealers) 
with an annual cost of $15,720 ($120 x 131 Level 1, Level 2, and Level 
3 broker-dealers).
    The SEC estimates that requiring Level 1 and Level 2 broker-dealers 
to maintain the records required by Sec.  __.5 in accordance with 
Exchange Act Rule 17a-4 will impose an initial burden of 13 hours per 
respondent and a total ongoing annual burden of 6 hours and $120 per 
respondent. The total burden for all Level 1 and Level 2 broker-dealers 
will be 637 hours initially (13 hours x 49 Level 1 and Level 2 broker-
dealers) and 294 hours annually (6 hours x 49 Level 1 and Level 2 
broker-dealers) with an annual cost of $5,880 ($120 x 49 Level 1 and 
Level 2 broker-dealers).
    The SEC estimates that requiring Level 1 and Level 2 broker-dealers 
to maintain the policies and procedures required by Sec.  __.11 in 
accordance with Exchange Act Rule 17a-4 will impose an initial burden 
of 13 hours per respondent and a total ongoing annual burden of 6 hours 
and $120 per respondent. The total burden for all Level 1 and Level 2 
broker-dealers will be 637 hours initially (13 hours x 49 Level 1 and 
Level 2 broker-dealers) and 294 hours annually (6 hours x 49 Level 1 
and Level 2 broker-dealers) with an annual cost of $5,880 ($120 x 49 
Level 1 and Level 2 broker-dealers).
    In the Supporting Statement accompanying the most recent extension 
of Exchange Act Rule 17a-4's collection of information, the SEC 
estimated that each registered broker-dealer spends 254 hours annually 
to ensure it is in compliance with Rule 17a-4 and produce records 
promptly when required, and $5,000 each year on physical space and 
computer hardware and software to store the requisite documents and 
information.\282\ Thus, for Level 3 broker-dealers, as a result of the 
collection of information, the total annual burden to ensure compliance 
with Rule 17a-4 and produce records promptly when required will be 260 
hours \283\ and $5,120 \284\ per Level 3 broker-dealer, or 21,320 hours 
and $419,840 per all 82 Level 3 broker-dealers. For Level 1 and Level 2 
broker-dealers, as a result of the collection of information, the total 
annual burden to ensure compliance with Rule 17a-4 and produce records 
promptly when required will be 272 hours \285\ and $5,360 \286\ per 
Level 1 and Level 2

[[Page 37755]]

broker-dealer, or 13,328 hours and $262,640 per all 49 Level 1 and 
Level 2 broker-dealers.
---------------------------------------------------------------------------

    \282\ See Supporting Statement for the Paperwork Reduction Act 
Information Collection Submission for Rule 17a-4, Collection of 
Information for Exchange Act Rule 17a-4 (OMB Control No. 3235-0279), 
Office of information and Regulatory Affairs, Office of Management 
and Budget, available at http://www.reginfo.gov/public/doPRAMain.
    \283\ 254 hours + 6 hour annual burden of maintaining the 
records required by Sec.  __.4(f) in accordance with Exchange Act 
Rule 17a-4.
    \284\ $5,000 + $ 120 annual cost of maintaining the records 
required by Sec.  __.4(f) in accordance with Exchange Act Rule 17a-
4.
    \285\ 254 hours + 6 hour annual burden of maintaining the 
records required by Sec.  __.4(f) in accordance with Exchange Act 
Rule 17a-4 + 6 hour annual burden of maintaining the records 
required by Sec.  __.5 in accordance with Exchange Act Rule 17a-4 + 
6 hour annual burden of maintaining the policies and procedures 
required by Sec.  __.11 in accordance with Exchange Act Rule 17a-4.
    \286\ $5,000 + $120 annual cost of maintaining the records 
required by Sec.  __.4(f) in accordance with Exchange Act Rule 17a-4 
+ $120 annual cost of maintaining the records required by Sec.  __.5 
in accordance with Exchange Act Rule 17a-4 + $120 annual cost of 
maintaining the policies and procedures required by Sec.  __.11 in 
accordance with Exchange Act Rule 17a-4.

                          Summary of Collection of Information Burdens per Record Type
----------------------------------------------------------------------------------------------------------------
                                                           Initial hourly     Annual hourly       Annual cost
                                                          burden estimate    burden estimate      estimate per
        Nature of information collection burden            per respondent     per respondent    respondent  (all
                                                         (all respondents)  (all respondents)     respondents)
----------------------------------------------------------------------------------------------------------------
Sec.   __.4(f) Recordkeeping for Level 1, Level 2, and          13 (1,703)            6 (786)     $120 ($15,720)
 Level 3 Broker-Dealers................................
Sec.   __.5 Recordkeeping for Level 1 and Level 2                 13 (637)            6 (294)        120 (5,880)
 Broker-Dealers........................................
Sec.   __.11 Policies and Procedures for Level 1 and              13 (637)            6 (294)        120 (5,880)
 Level 2 Broker-Dealers................................
                                                        ========================================================
----------------------------------------------------------------------------------------------------------------


                        Summary of Collection of Information Burdens per Respondent Type
----------------------------------------------------------------------------------------------------------------
                                                           Initial hourly     Annual hourly       Annual cost
                                                          burden estimate    burden estimate      estimate per
        Nature of information collection burden            per respondent     per respondent    respondent  (all
                                                         (all respondents)  (all respondents)     respondents)
----------------------------------------------------------------------------------------------------------------
Level 1 and Level 2 Broker-Dealers (49 total)..........         39 (1,911)           18 (882)     $360 ($17,640)
Level 3 Broker-Dealers (82 total)......................         13 (1,066)            6 (492)        120 (9,840)
----------------------------------------------------------------------------------------------------------------


  Summary of Collection of Information Burdens per Respondent Type Including Estimate of Annual Compliance With
                                                   Rule 17a-4
----------------------------------------------------------------------------------------------------------------
                                                             Annual hourly       Annual cost
                                                            burden estimate      estimate per
         Nature of information collection burden             per respondent    respondent  (all
                                                           (all respondents)     respondents)
-----------------------------------------------------------------------------------------------
Level 1 and Level 2 Broker-Dealers (49 total)............       272 (13,328)  $5,360 ($262,640)
Level 3 Broker-Dealers (82 total)........................       260 (21,320)    5,120 (419,840)
----------------------------------------------------------------------------------------------------------------

    As discussed above, the SEC estimates an increase of $120 for Level 
3 broker-dealers and $360 for Level 1 and Level 2 broker-dealers to the 
$5,000 spent each year by a broker-dealer on physical space and 
computer hardware and software to store the requisite documents and 
information as a result of the collection of information. The SEC 
estimates that respondents will not otherwise seek outside assistance 
in completing the collection of information or experience any other 
external costs in connection with the collection of information.
2. Investment Advisers Act Rule 204-2
    The currently-approved total annual burden estimate for rule 204-2 
is 1,986,152 hours. This burden estimate was based on estimates that 
10,946 advisers were subject to the rule, and each of these advisers 
spends an average of 181.45 hours preparing and preserving records in 
accordance with the rule. Based on updated data as of January 4, 2016, 
there are 11,956 registered investment advisers.\287\ This increase in 
the number of registered investment advisers increases the total burden 
hours of current rule 204-2 from 1,986,152 to 2,169,417, an increase of 
183,265 hours.\288\
---------------------------------------------------------------------------

    \287\ Based on data from the Commission's Investment Adviser 
Registration Depository (``IARD'') as of January 4, 2016.
    \288\ This estimate is based on the following calculations: 
(11,956 - 10,946) x 181.45 = 183,265; 183,265 + 1,986,152 = 
2,169,417.
---------------------------------------------------------------------------

    The proposed amendment to rule 204-2 would require covered 
investment advisers that are Level 1, Level 2, or Level 3 covered 
institutions to make and keep true, accurate, and current the records 
required by, and for the period specified in, Sec.  __.4(f) and, for 
those covered investment advisers that are Level 1 or Level 2 covered 
institutions, the records required by, and for the periods specified 
in, Sec. Sec.  __.5 and __.11.

[[Page 37756]]

    Based on SEC staff experience, the SEC estimates that the proposed 
amendment to rule 204-2 would increase each registered investment 
adviser's average annual collection burden under rule 204-2 by 2 hours 
\289\ for each of the three types of records required to be preserved 
pursuant to the collection of information.\290\ Therefore, for a 
covered investment adviser that is a Level 1 covered institution, the 
increase in its average annual collection burden would be from 181.45 
hours to 187.45 hours,\291\ and would thus increase the annual 
aggregate burden for rule 204-2 by 108 hours,\292\ from 2,169,417 hours 
to 2,169,525 hours.\293\ As monetized, the estimated burden for each 
such investment adviser's average annual burden under rule 204-2 would 
increase by approximately $450,\294\ which would increase the estimated 
monetized aggregate annual burden for rule 204-2 by $8,100, from 
$162,706,275 to $162,714,375.\295\ For a covered investment adviser 
that is a Level 2 covered institution, the increase in its average 
annual collection burden would be from 181.45 hours to 185.45 
hours,\296\ and would thus increase the annual aggregate burden for 
rule 204-2 by 84 hours,\297\ from 2,169,525 hours \298\ to 2,169,609 
hours.\299\ As monetized, the estimated burden for each such investment 
adviser's average annual burden under rule 204-2 would increase by 
approximately $300,\300\ which would increase the estimated monetized 
aggregate annual burden for rule 204-2 by $6,300, from $162,714,375 
\301\ to $162,720,675.\302\ For a covered investment adviser that is a 
Level 3 covered institution, the increase in its average annual 
collection burden would be from 181.45 hours to 183.45 hours,\303\ and 
would thus increase the annual aggregate burden for rule 204-2 by 1,260 
hours,\304\ from 2,169,609 hours \305\ to 2,170,869 hours.\306\ As 
monetized, the estimated burden for each such investment adviser's 
average annual burden under rule 204-2 would increase by approximately 
$150,\307\ which would increase the estimated monetized aggregate 
annual burden for rule 204-2 by $94,500, from $162,720,675 \308\ to 
$162,815,175.\309\ The SEC estimates that the proposed amendment does 
not result in any additional external costs associated with this 
collection of information for rule 204-2.
---------------------------------------------------------------------------

    \289\ The burden hours estimated by the SEC for amending 
Investment Advisers Act Rule 204-2 assumes that the covered 
investment adviser already has systems in place to comply with the 
general requirements of Investment Advisers Rule 204-2. Accordingly, 
the 2 burden hours estimated by the SEC for each type of record 
required to be preserved pursuant to these proposed rules is 
attributable solely to the burden associated with maintaining such 
record.
    \290\ The records required by Sec.  __.4(f), and for covered 
investment advisers that are Level 1 or Level 2 covered 
institutions, the records required by Sec.  __.5 and the policies 
and procedures required by Sec.  __.11.
    \291\ This estimate is based on the following calculation: 
181.45 existing hours + 6 new hours = 187.45 hours.
    \292\ This estimate is based on the following calculation: 18 
(Level 1 covered institution) advisers x 6 hours = 108 hours.
    \293\ This estimate is based on the following calculation: 
2,169,417 hours + 108 hours = 2,169,525 hours.
    \294\ This estimate is based on the following calculation: 6 
hours x $75 (hourly rate for an administrative assistant) = $450. 
The hourly wage used is from SIFMA's Management & Professional 
Earnings in the Securities Industry 2013, modified to account for an 
1800-hour work-year and inflation and multiplied by 5.35 to account 
for bonuses, firm size, employee benefits, and overhead.
    \295\ This estimate is based on the following calculations: 
2,169,417 hours x $75 = $162,706,275. 2,169,525 hours x $75 = 
$162,714,375. $162,714,375 - $162,706,275 = $8,100.
    \296\ This estimate is based on the following calculation: 
181.45 existing hours + 4 new hours = 185.45 hours.
    \297\ This estimate is based on the following calculation: 21 
(Level 2 covered institution) advisers x 4 hours = 84 hours.
    \298\ This estimate includes the increase in the annual 
aggregate burden for covered investment advisers that are Level 1 
covered institutions.
    \299\ This estimate is based on the following calculation: 
2,169,525 hours + 84 hours = 2,169,609 hours.
    \300\ This estimate is based on the following calculation: 4 
hours x $75 (hourly rate for an administrative assistant) = $300. 
The hourly wage used is from SIFMA's Management & Professional 
Earnings in the Securities Industry 2013, modified to account for an 
1800-hour work-year and inflation and multiplied by 5.35 to account 
for bonuses, firm size, employee benefits, and overhead.
    \301\ This estimate includes the monetized increase in the 
annual aggregate burden for covered investment advisers that are 
Level 1 covered institutions.
    \302\ This estimate is based on the following calculations: 
2,169,525 hours x $75 = $162,714,375. 2,169,609 hours x $75 = 
$162,720,675. $162,720,675 - $162,714,375 = $6,300.
    \303\ This estimate is based on the following calculation: 
181.45 existing hours + 2 new hours = 183.45 hours.
    \304\ This estimate is based on the following calculation: 630 
(Level 3 covered institution) advisers x 2 hours = 1,260 hours.
    \305\ This estimate includes the increase in the annual 
aggregate burden for covered investment advisers that are Level 1 or 
Level 2 covered institutions.
    \306\ This estimate is based on the following calculation: 
2,169,609 hours + 1,260 hours = 2,170,869 hours.
    \307\ This estimate is based on the following calculation: 2 
hours x $75 (hourly rate for an administrative assistant) = $150. 
The hourly wage used is from SIFMA's Management & Professional 
Earnings in the Securities Industry 2013, modified to account for an 
1800-hour work-year and inflation and multiplied by 5.35 to account 
for bonuses, firm size, employee benefits, and overhead.
    \308\ This estimate includes the monetized increase in the 
annual aggregate burden for covered investment advisers that are 
Level 1 or Level 2 covered institutions.
    \309\ This estimate is based on the following calculations: 
2,169,609 hours x $75 = $162,720,675. 2,170,869 hours x $75 = 
$162,815,175. $162,815,175 - $162,706,275 = $94,500.
---------------------------------------------------------------------------

E. Collection of Information Is Mandatory
    The collections of information will be mandatory for any broker-
dealer or covered investment adviser that is a covered institution 
subject to the proposed rules.
F. Confidentiality
    The information collected pursuant to the collections of 
information will be kept confidential, subject to the provisions of 
applicable law.
G. Retention Period of Recordkeeping Requirements
    The collections of information will not impose any retention period 
with respect to recordkeeping requirements. The retention period for 
the records required by Sec.  __.4(f) and the records required by Sec.  
__.5 is accounted for in the PRA estimates for the proposed rules.
H. Request for Comment
    Pursuant to 44 U.S.C. 3505(c)(2)(B), the SEC solicits comment to:
    1. Evaluate whether the proposed collections are necessary for the 
proper performance of its functions, including whether the information 
shall have practical utility;
    2. Evaluate the accuracy of its estimate of the burden of the 
proposed collections of information;
    3. Determine whether there are ways to enhance the quality, 
utility, and clarity of the information to be collected; and
    4. Evaluate whether there are ways to minimize the burden of 
collections of information on those who are to respond, including 
through the use of automated collection techniques or other forms of 
information technology.
    Persons submitting comments on the collection of information 
requirements should direct them to the Office of Management and Budget, 
Attention: Desk Officer for the Securities and Exchange Commission, 
Office of Information and Regulatory Affairs, Washington, DC 20503, and 
should also

[[Page 37757]]

send a copy of their comments to Brent J. Fields, Secretary, Securities 
and Exchange Commission, 100 F Street NE., Washington, DC 20549-1090, 
with reference to File No. S7-07-16. Requests for materials submitted 
to OMB by the SEC with regard to this collection of information should 
be in writing, with reference to File No. S7-07-16, and be submitted to 
the Securities and Exchange Commission, Office of FOIA Services, 100 F 
Street NE., Washington, DC 20549. As OMB is required to make a decision 
concerning the collections of information between 30 and 60 days after 
publication of this proposal, a comment to OMB is best assured of 
having its full effect if OMB receives it within 30 days of 
publication.

C. The Treasury and General Government Appropriations Act, 1999--
Assessment of Federal Regulations and Policies on Families

    NCUA and the FDIC have determined that this proposed rulemaking 
would not affect family well-being within the meaning of Section 654 of 
the Treasury and General Government Appropriations Act of 1999.\310\
---------------------------------------------------------------------------

    \310\ Public Law 105-277, 112 Stat. 2681 (1998).
---------------------------------------------------------------------------

D. Riegle Community Development and Regulatory Improvement Act of 1994

    The Riegle Community Development and Regulatory Improvement Act of 
1994 (``RCDRIA'') requires that each Federal Banking Agency, in 
determining the effective date and administrative compliance 
requirements for new regulations that impose additional reporting, 
disclosure, or other requirements on insured depository institutions, 
consider, consistent with principles of safety and soundness and the 
public interest, any administrative burdens that such regulations would 
place on depository institutions, including small depository 
institutions, and customers of depository institutions, as well as the 
benefits of such regulations. In addition, new regulations that impose 
additional reporting, disclosures, or other new requirements on insured 
depository institutions generally must take effect on the first day of 
a calendar quarter that begins on or after the date on which the 
regulations are published in final form.
    The Federal Banking Agencies note that comment on these matters has 
been solicited in the discussions of section __.1 and __.3 in Part II 
of the Supplementary Information, as well as other sections of the 
preamble, and that the requirements of RCDRIA will be considered as 
part of the overall rulemaking process. In addition, the Federal 
Banking Agencies also invite any other comments that further will 
inform the Federal Banking Agencies' consideration of RCDRIA.

E. Solicitation of Comments on Use of Plain Language

    Section 722 of the Gramm-Leach-Bliley Act \311\ requires the 
Federal Banking Agencies to use plain language in all proposed and 
final rules published after January 1, 2000. The Federal Banking 
Agencies invite comments on how to make these proposed rules easier to 
understand. For example:
---------------------------------------------------------------------------

    \311\ Public Law 106-102, section 722, 113 Stat. 1338 1471 
(1999).
---------------------------------------------------------------------------

     Have the agencies organized the material to suit your 
needs? If not, how could this material be better organized?
     Are the requirements in the proposed rules clearly stated? 
If not, how could the proposed rules be more clearly stated?
     Do the proposed rules contain language or jargon that is 
not clear? If so, which language requires clarification?
     Would a different format (grouping and order of sections, 
use of headings, paragraphing) make the proposed rules easier to 
understand? If so, what changes to the format would make the proposed 
rules easier to understand?
     What else could the Agencies do to make the regulation 
easier to understand?

F. OCC Unfunded Mandates Reform Act of 1995 Determination

    The OCC has analyzed the proposed rule under the factors set forth 
in section 202 of the Unfunded Mandates Reform Act of 1995 (``UMRA'') 
(2 U.S.C. 1532). Under this analysis, the OCC considered whether the 
proposed rule includes Federal mandates that may result in the 
expenditure by State, local, and tribal governments, in the aggregate, 
or by the private sector, of $100 million or more in any one year 
(adjusted annually for inflation). For the following reasons, the OCC 
finds that the proposed rule does not trigger the $100 million UMRA 
threshold. First, the mandates in the proposed rule do not apply to 
State, local, and tribal governments. Second, the overall estimate of 
the maximum one-year cost of the proposed rule to the private sector is 
approximately $50 million. For this reason, and for the other reasons 
cited above, the OCC has determined that this proposed rule will not 
result in expenditures by State, local, and tribal governments, or the 
private sector, of $100 million or more in any one year. Accordingly, 
this proposed rule is not subject to section 202 of the UMRA.

G. Differences Between the Federal Home Loan Banks and the Enterprises

    Section 1313(f) of the Safety and Soundness Act requires the 
Director of FHFA, when promulgating regulations relating to the Federal 
Home Loan Banks, to consider the differences between the Federal Home 
Loan Banks and the Enterprises (Fannie Mae and Freddie Mac) as they 
relate to: The Federal Home Loan Banks' cooperative ownership 
structure; the mission of providing liquidity to members; the 
affordable housing and community development mission; their capital 
structure; and their joint and several liability on consolidated 
obligations (12 U.S.C. 4513(f)). The Director also may consider any 
other differences that are deemed appropriate. In preparing this 
proposed rule, the Director considered the differences between the 
Federal Home Loan Banks and the Enterprises as they relate to the above 
factors, and determined that the rule is appropriate. FHFA requests 
comments regarding whether differences related to those factors should 
result in any revisions to the proposed rule.

H. NCUA Executive Order 13132 Determination

    Executive Order 13132 encourages independent regulatory agencies to 
consider the impact of their actions on state and local interests. In 
adherence to fundamental federalism principles, NCUA, an independent 
regulatory agency,\312\ voluntarily complies with the Executive Order. 
As required by statute, the proposed rule, if adopted, will apply to 
federally insured, state-chartered credit unions. These institutions 
are already subject to numerous provisions of NCUA's rules, based on 
the agency's role as the insurer of member share accounts and the 
significant interest NCUA has in the safety and soundness of their 
operations. Because the statute specifies that this rule must apply to 
state-chartered credit unions, NCUA has determined that the proposed 
rule does not constitute a policy that has federalism implications for 
purposes of the Executive Order.
---------------------------------------------------------------------------

    \312\ 44 U.S.C. 3502(5).
---------------------------------------------------------------------------

I. SEC Economic Analysis

A. Introduction
    As discussed above, section 956 of the Dodd-Frank Act requires the 
SEC, jointly with other appropriate Federal regulators, to prescribe 
regulations or

[[Page 37758]]

guidelines to require covered institutions to disclose information 
about their incentive-based compensation arrangements sufficient for 
the Agencies to determine whether their compensation structure provides 
an executive officer, employee, director or principal shareholder with 
excessive compensation, fees or benefits or could lead to material 
financial loss to the firm. Section 956 also requires the Agencies to 
jointly prescribe regulations or guidelines that prohibit any type of 
incentive-based compensation arrangements, or any feature of these 
arrangements, that the Agencies determine encourages inappropriate 
risks by covered institutions by providing excessive compensation to 
officers, employees, directors, or principal shareholders (``covered 
persons'') or that could lead to material financial loss to the covered 
institution. While section 956 requires rulemaking to address a number 
of types of financial institutions, the rule being proposed by the SEC 
would apply to broker-dealers registered with the SEC under section 15 
of the Securities Exchange Act (``broker-dealers'' or ``BDs'') and 
investment advisers, as defined in section 202(a)(11) of the Investment 
Advisers Act of 1940 (``investment advisers'' or ``IAs'').
    In connection with its rulemakings, the SEC considers the likely 
economic effects of the rules. This section provides the SEC's economic 
analysis of the main likely effects of the proposed rule on broker-
dealers and investment advisers that would be covered under the 
proposed rule. For purposes of this analysis, the SEC addresses the 
potential economic effects for covered BDs and IAs resulting from the 
statutory mandate and from the SEC's exercise of discretion together, 
recognizing that it is often difficult to separate the economic effects 
arising from these two sources. The SEC also has considered the 
potential costs and benefits of reasonable alternative means of 
implementing the mandate. Where practicable, the SEC has attempted to 
quantify the effects of the proposed rule; however, in certain cases 
noted below, the SEC is unable to provide a reasonable estimate because 
the SEC lacks the necessary data.
    In particular, because the SEC's regulation of individuals' 
compensation has historically been centered on disclosures by reporting 
companies, the SEC lacks information and data regarding the present 
incentive-based compensation practices of broker-dealers and investment 
advisers if those entities are not themselves reporting companies under 
the Exchange Act. In addition, in proposing these rules jointly for 
public comment, the Agencies have relied in part on the supervisory 
experience of the Federal Banking Agencies.\313\ Accordingly, for the 
purposes of evaluating the economic impact of the proposed rule, the 
SEC has considered outside analyses and other studies regarding the 
effects of incentive-based compensation that are not directly related 
to broker-dealers or investment advisers. In addition, the SEC is 
requesting that commenters provide data that will permit the SEC to 
perform a more direct analysis of the economic impact on broker-dealers 
and investment advisers that the proposed rules would have if adopted.
---------------------------------------------------------------------------

    \313\ See, e.g., OCC, Board, FDIC, and Office of Thrift 
Supervision, ``Guidance on Sound Incentive Compensation Policies'' 
(``2010 Federal Banking Agency Guidance''), 75 FR 36395 (June 25, 
2010), available at: http://www.federalreserve.gov/newsevents/press/bcreg/20100621a.htm. As discussed above, the Federal Banking 
Agencies have found that any incentive-based compensation 
arrangement at a covered institution will encourage inappropriate 
risks if it does not sufficiently expose the risk-takers to the 
consequences of their risk decisions over time, and that in order to 
do this, it is necessary that meaningful portions of incentive-based 
compensation be deferred and placed at risk of reduction or 
recovery. This economic analysis relies in part on these Agencies' 
supervisory experience described above.
---------------------------------------------------------------------------

    The SEC requests comment on all aspects of the economic effects, 
including the costs and benefits of the proposed rule and possible 
alternatives to the proposed rule. The SEC appreciates comments that 
include data or qualitative information that would enable it to 
quantify the costs and benefits associated with the proposed rule and 
alternatives to the proposed rule.
B. Broad Economic Considerations
    Economic theory suggests that even compensation practices that are 
optimal from the perspective of one set of stakeholders may not be 
optimal from the perspective of others. As discussed below, pay 
packages that are optimal from the point of view of certain 
shareholders may not be optimal from the point of view of taxpayers and 
other stakeholders.
    In particular, as discussed above, under certain facts and 
circumstances, even pay packages that are optimal from the point of 
view of shareholders may induce an excessive amount of risk-taking that 
could create potentially negative externalities for taxpayers. For 
example, also as discussed above, some have argued that during 
financial crises the losses of certain financial institutions have 
resulted in taxpayer assistance.\314\ To the extent that the proposed 
rule would curtail pay convexity \315\ by imposing restrictions of 
certain amounts, components, and features of incentive-based 
compensation, the proposed rule may have potential benefits by lowering 
the likelihood of an outcome that may induce negative externalities. 
The extent of these potential benefits would depend on specific facts 
and circumstances at the firm level and individual level, including 
whether the size, centrality, and business complexity of the firm and 
the position of the individual materially affect the level of risk, 
including risks that could lead to negative externalities. While 
academic literature does not provide clear evidence that broker-dealers 
and investment advisers have produced negative externalities for 
taxpayers,\316\ the proposed rule may address scenarios where such 
externalities could nonetheless arise because the incentive-based 
compensation arrangements at a broker-dealer or investment adviser 
generate differences in risk preferences between managers \317\ and 
taxpayers.
---------------------------------------------------------------------------

    \314\ See Gorton, G., 2012. Misunderstanding Financial Crises: 
Why We Don't See Them Coming, Oxford University Press; French et 
al., 2010. Excerpts from The Squam Lake Report: Fixing the Financial 
System. Journal of Applied Corporate Finance 22, 8-21.
    \315\ Pay convexity describes the shape of the payoff curve as a 
result of compensation arrangements. More convex payoff curves 
provide higher rewards for taking on risk.
    \316\ In the academic literature, some studies relate to a broad 
spectrum of firms in different industries, while other studies 
related to firms, primarily banks, in the financial services sector. 
The SEC is not aware of studies that focus on broker-dealers and 
investment advisers. While certain findings in the financial 
services sector may apply also to broker-dealers and investment 
advisers, any generalization is subject to a number of limitations. 
For example, BDs and IAs differ from other financial services firms 
with respect to business models, nature of the risks posed by the 
institutions, and the nature and identity of the persons affected by 
those risks.
    \317\ The SEC's economic analysis uses the term ``managers'' in 
an economic (rather than organizational) connotation as the persons 
or entities that are able to make decisions on behalf of, or that 
impact, another person or entity. Thus, managers in this context 
would include covered persons such as senior executive officers and 
significant risk-takers.
---------------------------------------------------------------------------

    From an economic standpoint, when the risk preferences of managers 
(agents) differ from the risk preferences of stakeholders (principals) 
of a firm, risk-taking may be considered inappropriate from the point 
of view of a particular stakeholder.\318\ While the economic

[[Page 37759]]

theory mainly focuses on the principal-agent relationship between 
managers and shareholders, an agency problem may also exist between 
managers and taxpayers and between managers and debtholders. For 
example, certain levels of risk-taking (e.g., those associated with 
investments in R&D-intensive activities) may be optimal \319\ for 
shareholders but considered to be excessive for debtholders. In 
general, debtholders are likely to require a rate of return on their 
investment that is proportionate to the riskiness of the firm and to 
put in place covenants in the contracts governing the debt that 
restrict those managerial actions that, in their view, may constitute 
inappropriate risk-taking but that shareholders may find 
appropriate.\320\
---------------------------------------------------------------------------

    \318\ The literature in economics and finance typically refers 
to a principal-agent model to describe the employment relationship 
between shareholders and managers of a firm. The principal 
(shareholder) hires an agent (manager) to operate the firm. More 
generally, the principal-agent model is also used to describe the 
relationship between managers and stakeholders. For example, see 
Jensen, M., Meckling, W. 1976. Theory of the Firm: Managerial 
Behavior, Agency Costs and Ownership Structure. Journal of Financial 
Economics 3, 305-360.
    \319\ The economic literature uses the term of ``optimal'' 
(``suboptimal'') level of risk-taking in a technical manner to 
describe the alignment (misalignment) in risk preferences between 
managers and a particular stakeholder. Here ``optimal'' means from 
the point of view of a particular stakeholder (e.g., shareholders). 
Hereafter, consistently with the economic literature, the SEC's 
economic analysis uses these terms without any normative connotation 
or implication.
    \320\ Both managers and shareholders have an incentive to engage 
in activities that promise high payoffs if successful even if they 
have a low probability of success. If such activities turn out well, 
managers and shareholders capture most of the gains, whereas if they 
turn out badly debtholders bear most of the costs. In the principal-
agent relationship between managers and debtholders, inappropriate 
risk taking would amount to managers' actions that transfer risks 
from shareholders to debtholders and that benefit shareholders at 
the expense of debtholders. See Jensen, M., Meckling, W. 1976. 
Theory of the Firm: Managerial Behavior, Agency Costs and Ownership 
Structure. Journal of Financial Economics 3, 305-360.
---------------------------------------------------------------------------

    Tying managerial compensation to firm performance aims at aligning 
the incentives of management with the interests of shareholders.\321\ 
Managers are likely to be motivated by drivers other than their 
explicit compensation, including for example career advancements, 
personal pride, and job retention concerns. Beyond that, making their 
compensation in part depend on firm performance could incentivize 
managers to exert effort and make decisions that maximize shareholder 
value. In a principal-agent relationship between shareholders and 
managers, there may be an incentive misalignment that may give rise to 
agency problems between the parties: For example, managers may take on 
projects that benefit their personal wealth but do not necessarily 
increase the value of the firm. Absent a variable component in the 
compensation arrangements that encourages risk-taking, risk averse and 
undiversified managers \322\ may take less risk than is optimal from 
the point of view of shareholders.\323\
---------------------------------------------------------------------------

    \321\ See Ibid.
    \322\ The differential degree of diversification between 
managers' and shareholders' portfolios may lead to a misalignment of 
managerial incentives from optimal risk-taking from the point of 
view of shareholders. In general, executives are relatively 
undiversified compared to the average investor, because a 
significant fraction of executives' wealth is invested into the 
companies they operate, through the value of their firm-specific 
human capital and their portfolio holdings, including their 
compensation-related claims. The concentration of managerial wealth 
in their employer company may lead to managerial aversion towards 
value-enhancing but risky projects since such projects can place 
undiversified managerial wealth at heightened levels of risk. See 
Hall, B., and Murphy, K. 2002. Stock Options for Undiversified 
Executives. Journal of Accounting and Economics 33, 3-42.
    \323\ Most managers would operate in a multi-period framework. 
In this environment, managers would still have incentives to exert 
effort and make decisions that maximize shareholder value due to 
career concerns and expectations about future wages.
---------------------------------------------------------------------------

    With an aim to incentivize managers to take on risk that is optimal 
for shareholders and to attract and retain managerial talent, 
managerial compensation arrangements most often include incentive-based 
compensation, which is the variable component of compensation that 
serves as an incentive or a reward for performance.\324\ Incentive-
based compensation arrangements typically include \325\ performance-
based compensation whose award is conditional on achieving specified 
performance measures that are evaluated over a certain time period 
(i.e., short-term and long-term incentive plans), in absolute terms or 
in relation to a peer group. It encompasses a wide range of forms of 
compensation instruments. Among these forms, equity-based compensation 
(e.g., performance share units, restricted stock units, and stock 
option awards) ties managerial wealth to stock performance to motivate 
managers to take actions--exert effort and take risks--that are more 
directly aligned with the interests of shareholders. Equity awards are 
typically subject to multi-year vesting schedules and vesting 
conditions restricting managers from unwinding their equity positions 
during vesting periods. Relatedly, some managers are often prohibited 
from hedging their equity positions in their firm's stock against any 
downside in the stock value.
---------------------------------------------------------------------------

    \324\ Incentive-based compensation addresses the fact that 
shareholders cannot observe how much effort managers exert or should 
exert. Because shareholders do not know and cannot specify every 
action managers should take in every scenario, shareholders delegate 
many of the decisions to managers by compensating them based on the 
results from those decisions.
    \325\ See, for example, Frydman, C., and R. Saks, 2010. 
Executive Compensation: A New View from a Long-Term Perspective, 
1936-2005. Review of Financial Studies 23, 2099-2138.
---------------------------------------------------------------------------

    Incentivizing managers through compensation to take on 
shareholders' preferred amount of risk requires a delicate balancing 
act, because different combinations of amounts, components and features 
of incentive-based compensation may make managerial pay more or less 
sensitive to firm risk than the level that is desired by shareholders 
to maximize their return. In particular, different combinations may 
make pay a nonlinear (in particular, convex) function of performance; 
in other words, a greater increment in payoffs is realized in the case 
of high performance, compared to when performance is moderate or poor. 
While there has been ample debate about how certain characteristics of 
incentive-based compensation may affect pay convexity and induce risk-
taking, the economic literature has not conclusively identified a 
specific amount, component, or feature of incentive-based compensation 
that uniformly leads to inappropriate risk-taking, due to differential 
facts and circumstances at both the firm level and individual level.
    For example, stock options and risk grants are often seen as a form 
of incentive-based compensation that, under certain conditions, may 
lead to incentives for taking inappropriate risk from shareholders' 
point of view.\326\ Compared to cash incentives or restricted stock 
units, stock options have an asymmetric payoff structure since they 
provide the option holder with unlimited upside potential and limited 
downside. In particular, given that a positive outcome from risk-taking 
is a positive payoff, whereas a negative outcome does not symmetrically 
penalize the option holder, the design of stock options is likely to 
encourage managers to undertake risks. The empirical research on the 
effect of stock options on risk-taking does in general support a 
positive relation between option-based compensation and risk-
taking;\327\ however, as a whole, the academic evidence is mixed on 
whether stock options induce inappropriate risk-

[[Page 37760]]

taking from the point of view of shareholders.
---------------------------------------------------------------------------

    \326\ See Frydman and Jenter. CEO Compensation. Annual Review of 
Financial Economics (2010).
    \327\ See Guay, W. 1999. The sensitivity of CEO wealth to equity 
risk: An analysis of the magnitude and determinants. Journal of 
Financial Economics 53, 43-71. Stock options, as opposed to common 
stockholdings, increase the sensitivity of CEOs' wealth to equity 
risk. The study documents a positive relation between the convexity 
in compensation arrangements and stock return volatility suggesting 
that such compensation arrangements are related to riskier investing 
and financing decisions. Stock options are mostly used in companies 
where underinvestment is value-increasing but risky projects may 
lead to significant losses in the value of these companies.
---------------------------------------------------------------------------

    Some studies show that the relation between option-based 
compensation and risk-taking incentives is not uniform across different 
firms, and the incentives to undertake risk may vary depending on 
certain conditions.\328\ For example, options that are deep in-the-
money may lead the option holder to moderate risk exposure to protect 
the value of the option. On the other hand, options that are deep out-
of-the-money may provide incentives for excessive risk-taking. 
Additionally, there is significant variation across companies with 
regard to the use of options in compensation arrangements. Stock 
options are a relatively more significant component of compensation 
arrangements for executives in companies where risk-taking is important 
for maximizing shareholder value.\329\
---------------------------------------------------------------------------

    \328\ See Ross, S. 2004. Compensation, Incentives, and the 
Duality of Risk Aversion and Riskiness. Journal of Finance 59, 207-
225; Carpenter, J. 2000. Does Option Compensation Increase 
Managerial Risk Appetite? Journal of Finance 55, 2311-2332. Both 
studies question the common belief that stock options unequivocally 
induce holders to undertake more risk. Although the asymmetric 
payoff structure of options is likely to encourage risk-taking in 
some cases, there are also circumstances where options may lead to 
decreased appetite for risk taking by option holders.
    \329\ See Guay (1999).
---------------------------------------------------------------------------

    Another example of a characteristic in incentive-based compensation 
arrangements that is commonly considered to potentially provide 
incentives for actions that carry undesired risks is the 
disproportionate use of short-term (e.g., measured over a period of one 
year) performance measures (i.e., accounting, stock price-based, or 
nonfinancial measures) that may steer managers toward short-termism 
without adequate regard of the long-term risks potentially posed to 
long-term firm value.\330\ In doing so, managers may reap the rewards 
of their actions in the short run but may not participate in the 
potentially negative outcomes that may materialize in the long run. 
Short-termism may lead to investment distortions in the long run, such 
as under- \331\ or over-investment,\332\ that are potentially 
detrimental to shareholder value. Some academic studies suggest that 
managers' focus on short-term performance may arise simply out of their 
reputation and career concerns, and compensation awards tied to short-
term performance measures may accentuate the tendency toward short-
termism.\333\
---------------------------------------------------------------------------

    \330\ See Bizjak, J., Brickley, J., Coles, J. 1993. Stock-based 
incentive compensation and investment behavior. Journal of 
Accounting and Economics 16, 349-372. The authors argue that 
managerial concern about current stock prices could lead management 
to distort optimal investment decisions in an effort to influence 
the current stock price. Such short-termism is likely to be 
exacerbated when there is a significant information asymmetry 
between management and investors. The study argues that compensation 
arrangements with longer horizons are a potential solution to such 
behavior, and finds that firms with higher information asymmetries 
between management and shareholders actually use compensation 
arrangements with relatively longer horizons.
    \331\ See Stein, J. 1989. Efficient Capital Markets, Inefficient 
Firms: A Model of Myopic Corporate Behavior. Quarterly Journal of 
Economics 104, 655-669.
    \332\ See Bebchuk, L., Stole, L. 1993. Do Short-Term Objectives 
Lead to Under- or Overinvestment in Long-Term Projects? Journal of 
Finance 48, 719-729. The paper develops a model showing that, 
depending on the nature of the information asymmetry between 
management and shareholders, either under- or over-investment in 
long-run projects is likely to occur. When shareholders cannot 
observe the level of investment in long-term projects, the model 
predicts that managers would underinvest. When shareholders can 
observe the level of investment but not the productivity of such 
investment, then managers have incentives to over-invest.
    \333\ See Narayanan, M.P. 1985. Managerial Incentives for Short-
Term Results. Journal of Finance 40, 1469-1484; and Stein, J. 1989. 
Efficient Capital Markets, Inefficient Firms: A Model of Myopic 
Corporate Behavior. Quarterly Journal of Economics 104, 655-669. 
These studies examine managerial incentives to focus on shorter-term 
performance at the expense of longer-term value. When managers have 
information about firm decisions that investors do not have, 
focusing on short-term performance may be an optimal strategy from 
managers to enhance their perceived skill and reputation, as well as 
achieve higher compensation. The studies also argue that even if the 
market anticipates such short-termism from managers, the optimal 
strategy for managers would still be to focus on short-term results. 
Narayanan (1985) also shows that short-termism can be partially 
curbed by offering longer-term contracts to managers.
    A survey of Chief Financial Officers indicates that, among other 
motivations, career concerns and reputation act as leading 
motivations for the significant focus of executives on delivering 
short-term performance (e.g., quarterly earnings expectations). The 
survey also documents that executives are willing to forgo long-term 
value enhancing activities and projects in order to deliver on 
short-term performance targets. See Graham, J., Harvey, C., and 
Rajgopal, S. 2005. The Economic Implications of Corporate Financial 
Reporting. Journal of Accounting and Economics 40, 3-73.
---------------------------------------------------------------------------

    Studies document that short-term incentive plans or annual bonuses 
typically represent a small fraction of executive compensation.\334\ 
Additionally, a recent study provides evidence of a significant 
increase in the number of firms granting multi-year accounting-based 
performance incentives to their chief executive officers 
(``CEOs'').\335\ Firms with relatively less volatile accounting 
performance measures and a stronger presence of long-term shareholders 
are more likely to utilize these compensation arrangements. As a whole, 
the academic evidence is mixed on whether short-term incentive plans 
induce inappropriate risk-taking from the point of view of certain 
shareholders. However, there is evidence that certain equity-based 
compensation arrangements may provide incentives for earnings 
management \336\ and misreporting \337\ that could lead to lower long-
term shareholder value. Finally, there is also evidence that 
compensation contracts with relatively shorter horizons are positively 
related (in a statistical sense) to proxies for earnings 
management.\338\
---------------------------------------------------------------------------

    \334\ See Frydman, C., and R. Saks, 2010. Executive 
Compensation: A New View from a Long-Term Perspective, 1936-2005. 
Review of Financial Studies 23, 2099-2138. The paper documents the 
evolution of various characteristics of executive compensation 
arrangements for the 50 largest U.S. companies since 1936. Long-term 
pay including deferred bonuses in the form of restricted stock and 
stock options comprised the largest part of executive compensation 
in recent years. For example, 35% of total executive pay for these 
companies was in the form of long-term bonuses in the form of 
restricted stock in 2005.
    \335\ See Li, Z., and L. Wang, 2013. Executive Compensation 
Incentives Contingent on Long-Term Accounting Performance, Working 
Paper. The study documents a significant increase in the use of 
long-term accounting performance plans for CEOs of S&P500 companies. 
More specifically, the study documents that 43% of S&P500 companies 
used long-term accounting performance plans in CEO compensation 
arrangements in 2008, compared to 16% of S&P500 companies in 1996. 
In general terms, these plans usually rely on a three-year 
performance measurement period of various accounting measures of 
performance such as earnings, revenues, cash flows and other metrics 
to determine payouts to CEOs in the form of mostly equity or cash. 
The paper does not find evidence that such compensation arrangements 
are used by CEOs to extract excessive compensation.
    \336\ See Bergstresser, D., Philippon, T. 2006. CEO incentives 
and earnings management. Journal of Financial Economics 80, 511-529. 
The paper presents evidence that highly incentivized CEOs, as 
measured by the significance of stock and options in CEOs' 
compensation arrangements, are more likely to engage in earnings 
management that misrepresents the true economic performance of a 
company, with the intent to personally profit from such 
misrepresentation of performance. Although tying CEOs' wealth to 
company performance aims at aligning the incentives of CEOs with 
those of shareholders, the strength of such incentives may lead to 
unintended consequences such as incentives to misrepresent company 
performance in efforts to increase the value of their compensation.
    \337\ See Burns, N., Kedia, S. 2006. The impact of performance-
based compensation on misreporting. Journal of Financial Economics 
79, 35-67. The study provides empirical evidence that CEOs whose 
option portfolios are more sensitive to the stock price of the 
company are more likely to misreport their performance. The paper 
does not find any evidence that the sensitivity of other components 
of performance-based compensation to stock price, such as restricted 
stock and bonuses, are related to the propensity to misreport 
performance. The asymmetric payoff structure of stock options 
provides incentives to CEOs to misreport because of the limited 
downside risk associated with the detection of misreporting.
    \338\ See Gopalan, R., Milbourn, T., Song, F., and Thakor, A. 
2014. Duration of Executive Compensation. Journal of Finance 69, 
2777-2817. The paper constructs a measure of executive pay duration 
that reflects the vesting periods of different pay components to 
investigate its association with short-termism. Pay duration is 
positively related to growth opportunities, long-term assets, R&D 
intensity, lower risk and better recent stock performance. Longer 
CEO pay duration is negatively related with income increasing 
accruals.

---------------------------------------------------------------------------

[[Page 37761]]

    The presence of a number of mitigating factors may explain why 
evidence is inconclusive on the effects of incentive-based compensation 
on inappropriate risk-taking. One such factor is corporate governance 
and, more specifically, board of directors oversight over executive 
compensation. The board of directors, as an agent of shareholders, may 
monitor managers and review their performance (e.g., through the 
compensation committee of the board of directors) in the case of 
decreases in shareholder value that, among other factors, may be a 
result of inappropriate risk-taking.\339\ Also, corporate boards may 
attempt to determine compensation arrangements for executives in a way 
that aligns executives' interests with those of shareholders. The 
empirical evidence on the effectiveness of board of directors oversight 
over executive compensation is mixed. One study finds evidence 
suggesting that certain boards are not effective in setting executive 
compensation because executives are often rewarded for performance due 
to luck.\340\ Another study provides evidence that CEOs play an 
important role in the nomination and selection of board of directors 
members, suggesting that board of directors oversight may be impaired 
as a result.\341\ Other studies find that firms with strong governance 
are better than firms with weak governance at monitoring the CEO and 
have better control of size and structure of CEO pay.\342\
---------------------------------------------------------------------------

    \339\ While the SEC is not aware of any literature that directly 
examines inappropriate risk-taking and managerial retention 
decisions, there is evidence in the academic literature documenting 
a higher likelihood of managerial turnover following poor 
performance measured with stock returns or accounting measures of 
performance (See for example, Engel, E., Hayes, R., and Wang, X. 
2003. CEO Turnover and Properties of Accounting Information. Journal 
of Accounting and Economics 36, 197-226; and Farell, K., and 
Whidbee, D. 2003. The Impact of Firm Performance Expectations on CEO 
Turnover and Replacement Decisions. Journal of Accounting and 
Economics 36, 165-196.).
    \340\ See Bertrand, M., and S. Mullainathan, 2001. Are CEOs 
rewarded for luck? The ones without principals are. Quarterly 
Journal of Economics 116, 901-932. The paper examines whether the 
component of firm performance that is outside of managerial control 
is related to managerial compensation. According to the efficient 
contracting view of compensation, i.e. compensation arrangements are 
used to mitigate principal-agent problems, executives should not be 
rewarded (nor penalized) for performance due to luck. The authors 
propose a `skimming view' for managerial compensation where CEOs 
capture the compensation setting process and find evidence that CEOs 
of oil companies get rewarded when changes in oil prices induce 
favorable changes in company performance. See also Bebchuk, L.A., 
Fried, J.M., Walker, D.I., 2002. Managerial power and rent 
extraction in the design of executive compensation. University of 
Chicago Law Review 69, 751-846.
    \341\ See Coles, J., Daniel, N., and Naveen, L. Co-opted Boards. 
2014. Review of Financial Studies 27, 1751-1796. The study examines 
whether independent directors that are appointed after the current 
CEO assumed office are effective monitors of the CEO. The findings 
show that there is a difference in the monitoring efficiency between 
independent directors holding their position prior to the current 
CEO's appointment vs. independent directors that join the board of 
directors after the current CEO has assumed office (Co-opted board 
members). The percentage of `co-opted' board members in a company is 
negatively related with various measures of board monitoring. For 
example, these companies tend to pay their CEOs more and have lower 
turnover-performance sensitivity (i.e., CEOs are less likely to be 
fired following deteriorating firm performance). The study questions 
whether independent directors appointed after CEO assumed office are 
really independent to the CEO.
    Relatedly, another study finds that on average directors receive 
a very high level of votes in elections, in the post-SOX era. The 
evidence points to the fact that if a director is slated, she is 
elected. However, the study also finds evidence that lower levels of 
director votes lead to reductions in `abnormal' compensation and an 
increase in the level of CEO turnover. This latter result is 
particularly strong when these directors serve as chair or members 
of the compensation committee. See Cai, J., Garner, J., and Walking 
R. 2009. Journal of Finance 64, 2389-2421.
    \342\ See Core, J., R.W. Holthausen, and D.F. Larcker. 1999. 
Corporate Governance, Chief Executive Officer Compensation, and Firm 
Performance. Journal of Financial Economics 51, 371-406. The paper 
finds that board and ownership structure explain differences in CEO 
compensation across firms to a significant extent. Weaker governance 
structures are related to greater agency problems resulting in 
higher CEO compensation.
    See Chhaochharia, V., and Grinstein, Y. 2009. CEO Compensation 
and Board Structure. Journal of Finance 64, 231-261, showing that 
companies that were least compliant with new regulations issued in 
2002 by NYSE and NASDAQ (regarding governance listing standards) 
decreased compensation to their CEOs to a significant extent. The 
decrease in CEO compensation is mainly attributable to decreases in 
bonus and stock-based compensation. The results suggest that 
requirements for board of directors structure and procedures have a 
significant effect on the structure and size of CEO compensation. 
See also Fahlenbrach, R. 2009. Shareholder Rights, Boards, and CEO 
Compensation. Review of Finance 13, 81-113, finding evidence of a 
substitution effect between compensation and other governance 
mechanisms.
---------------------------------------------------------------------------

    Another example of a mitigating factor is the implementation of 
risk controls over business activities that academic studies have 
generally found effective at curbing inappropriate risk-taking. One 
study \343\ examines the relation between risk controls at bank holding 
companies (``BHCs'') and outcomes related to risk-taking, such as the 
fraction of loans that are non-performing, during the financial crisis. 
In this study, the strength and quality of risk controls are proxied by 
the existence, independence, experience and centrality of the Chief 
Risk Officer and the corresponding Risk Committee. The study finds that 
BHCs with strong risk controls during years preceding the crisis had 
lower frequencies of underperforming loans and better operating and 
stock performance during the crisis. In this study, this relation was 
not significant in the years outside of the financial crisis indicating 
that strong risk controls, as measured by this study, curtailed extreme 
risk exposures only during the financial crisis. Another study \344\ 
shows that lenders with relatively powerful risk managers, as measured 
by the level of the risk manager's compensation relative to the level 
of named executive officers' compensation, experience lower loan 
default rates, interpreting this finding as evidence that strong risk 
management is effective in reducing the origination of low quality 
loans.
---------------------------------------------------------------------------

    \343\ See Ellul, A., Yerramilli, V. 2013. Stronger Risk 
Controls, Lower Risk: Evidence from U.S. Bank Holding Companies. 
Journal of Finance 68, 1757-1803.
    \344\ See Keys, B., Mukherjee, T., Seru, A., Vig, V. 2009. 
Financial regulation and securitization: Evidence from subprime 
loans. Journal of Monetary Economics 56, 700-720.
---------------------------------------------------------------------------

    Another mechanism that could play a mitigating role at curtailing 
the potential effects of incentive-based compensation on inappropriate 
risk-taking is reputation and career concerns of executives. On one 
hand, some studies show that managers' concerns about the effects of 
current performance on their future compensation are important in 
affecting managerial incentives, even in the absence of formal 
compensation contracts.\345\ For example, executives with greater 
career concerns typically have an incentive to take less risk than 
optimal for the company \346\ and an executive's pay-for-performance 
sensitivity is higher as the executive becomes older.\347\ This 
suggests that

[[Page 37762]]

inappropriate risk-taking could be less severe for younger executives, 
for whom there are more periods over which to spread the reward for 
their efforts.\348\ On the other hand, as mentioned above, some studies 
also argue that career concerns can lead executives to focus on 
delivering short-term performance to enhance their present reputation, 
at the expense of long-term value.\349\
---------------------------------------------------------------------------

    \345\ See Gibbons, Robert, and Kevin J. Murphy. 1992. Optimal 
incentive contracts in the presence of career concerns: Theory and 
evidence, Journal of Political Economy 100, 468-505. The paper shows 
that career concerns can have important effects on incentives even 
in the absence of formal contracts. The importance of career 
concerns as a motivating mechanism is particularly relevant for 
younger managers whose ability is not yet established in the labor 
market. Moreover, the evidence shows that CEOs' pay-for-performance 
sensitivity is stronger for CEOs closer to retirement, consistent 
with the idea that career concerns are not strong for older CEOs and 
are thus re-enforced through formal contracts.
    \346\ See Holmstrom, B. 1999. Managerial Incentive Problems: A 
Dynamic Perspective. Review of Economic Studies 66, 169-182. The 
study models incentives for effort and risk taking by agents in the 
presence of career concerns. With regards to risk taking, the model 
shows that younger managers whose talent or ability is not yet known 
to the market may be reluctant to choose risky projects that are 
optimal from a shareholders' perspective.
    \347\ See Gibbons, Robert, and Kevin J. Murphy, 1992. Optimal 
incentive contracts in the presence of career concerns: Theory and 
evidence, Journal of Political Economy 100, 468-505.
    \348\ Young CEOs are likely to differ in other dimensions such 
as character, knowledge, and experience and hence establishing a 
causal effect of career concerns on risk taking could be difficult. 
See Cziraki, P., and M. Xu, 2013. CEO career concerns and risk-
taking, working paper.
    \349\ See Narayanan, M.P. 1985. Managerial Incentives for Short-
Term Results. Journal of Finance 40, 1469-1484; and Stein, J. 1989. 
Efficient Capital Markets, Inefficient Firms: A Model of Myopic 
Corporate Behavior. Quarterly Journal of Economics 104, 655-669.
---------------------------------------------------------------------------

    Some studies argue that compensation structures did not encourage 
inappropriate risk-taking and that managers were severely penalized 
since their portfolio values suffered considerably during the financial 
crisis.\350\ According to these studies, executives held significant 
amounts of their financial institutions' equity in the form of stock 
options and restricted stock when the crisis occurred and the value of 
these holdings declined dramatically and quickly, wiping out most of 
their value. The fact that executives were still significantly exposed 
to firm performance by holding on to stock options and restricted stock 
units when the crisis occurred can be viewed as an indicator that these 
executives had no knowledge of the significant risks associated with 
their actions.\351\ According to this view, executives were held 
accountable and penalized upon the realization of the risks undertaken.
---------------------------------------------------------------------------

    \350\ See Murphy, K. 2009. Compensation Structure and Systemic 
Risk. U.S.C. Marshall School of Business Working Paper. Compensation 
for CEOs and other named executive officers (NEOs) significantly 
suffered during the crisis. For TARP recipient institutions: Bonuses 
declined by approximately 80% from 2007 to 2008, and the value of 
stock options and restricted stock held by NEOs declined by more 
than 80% during the same time period. Executive compensation also 
significantly declined for non-TARP recipients but the decline was 
lower than for TARP recipients.
    \351\ See Fahlenbrach, R., Stulz, R. 2011. Bank CEO Incentives 
and the Credit Crisis. Journal of Financial Economics 99, 11-26. The 
study examines the link between bank performance during the crisis 
and CEO incentives from compensation arrangements preceding the 
crisis. The evidence shows that banks whose CEOs' incentives were 
better aligned with the interests of shareholders performed worse 
during the crisis. The authors argue that a potential explanation 
for their findings is that CEOs with better aligned incentives 
undertook higher risks before the crisis; such risks were not 
suboptimal for shareholders at the point in time when they were 
undertaken. This explanation is also corroborated by the fact that 
CEOs did not unload their equity holdings prior to the crisis and, 
as a result, their wealth significantly declined.
---------------------------------------------------------------------------

    However, some other studies argue that, whereas bank executives 
lost significant amounts of wealth tied to their stock and stock option 
holdings during the crisis, they also received significant amounts of 
compensation during the years leading up to the financial crisis.\352\ 
Significant amounts of short-term bonuses were paid in the years 
preceding the crisis, even to executives of financial institutions that 
failed soon thereafter. While bank executives walked away with 
significant gains during the years leading up to the crisis, investors 
suffered significant losses in their investments in these institutions 
and, in some cases, taxpayers provided capital support to save these 
institutions from default. Thus, the underlying actions that generated 
significant positive performance and resulted in significant payouts to 
executives in the short run were also responsible for the realization 
of the associated risks in the long run. Another study \353\ finds that 
risk-taking incentives for CEOs at large commercial banks substantially 
increased around 2000 and suggests that this increase in risk-taking 
incentives was, at least partly, a response to growth opportunities 
resulting from deregulation. The study also finds that CEOs responded 
to the increased risk-taking incentives by increasing both systematic 
and idiosyncratic risks. CEOs with strong risk-taking incentives were 
also more likely to invest in mortgage backed securities; this finding 
is interpreted as knowledge on behalf of these CEOs regarding the risks 
associated with such investments. Finally, the study finds that, 
whereas boards of directors responded by moderating risk-taking 
incentives in situations where these incentives were particularly 
strong, such an effect was absent at the very largest banks with strong 
growth opportunities.
---------------------------------------------------------------------------

    \352\ See Bebchuk, L., Cohen, A., Spamann, H. 2010. The Wages of 
Failure: Executive Compensation at Bear Stearns and Lehman 2000-
2008. Yale Journal on Regulation 27, 257-282. The study presents 
details regarding payouts made to CEOs and executives of Bear Sterns 
and Lehman Brothers during the 2000-2008 period. During the 2000-
2008 period, executive teams at Bear Sterns cashed out a total of 
$1.4 billion in cash bonuses and equity sales whereas the executives 
at Lehman cashed out a total of $1 billion. The authors argue that 
the divergence between how top executives and their shareholders 
fared may suggest that pay arrangements provided incentives for 
excessive risk taking.
    See Bhagat, S., Bolton, B. 2013. Bank Executive Compensation and 
Capital Requirements Reform. Working Paper. The study examines, 
among other things, 2000-2008 net payoffs to CEOs of 14 financial 
institutions that received TARP assistance during the crisis. 
Consistent with the findings of Bebchuk et al. (2010), this study 
shows that CEOs of TARP assisted institutions cashed out significant 
amounts of compensation prior to the crisis, but also suffered 
significant losses when the crisis hit. The authors find that TARP 
CEOs cashed out significantly higher amounts of compensation during 
the 2000-2008 period compared to other institutions that did not 
receive TARP assistance; the finding is interpreted as evidence that 
TARP CEOs were aware of the increased risks associated with their 
actions and significantly limited their exposure to firm performance 
before the crisis hit.
    \353\ See DeYoung, R., Peng, E., Yan, Meng. 2013. Executive 
Compensation and Business Policy Choices at U.S. Commercial Banks. 
Journal of Financial and Quantitative Analysis 48, 165-196. The 
study examines CEOs' risk-taking incentives at large commercial 
banks over the 1995-2006 period. The authors link the increase in 
risk-taking incentives at these banks to growth opportunities due to 
deregulation. They find that board of directors moderated CEO risk-
taking incentives but this effect is absent at the largest banks 
with strong growth opportunities and a history of highly aggressive 
risk-taking incentives.
---------------------------------------------------------------------------

    Finally, there are also studies that argue that compensation 
structures were not responsible for the differential risk-taking and 
performance of financial institutions during crises. In particular, a 
study argues that the differential risk culture across banks determines 
the differential performance of these institutions.\354\ For example, 
banks that performed poorly during the 1998 crisis were also found to 
perform poorly, and had higher failure rates, during the recent 
financial crisis. Another recent study argues that, prior to 2008, 
risk-taking was inherently different across financial institutions and 
the fact that high-risk financial institutions paid high amounts of 
compensation to their executives was not an indicator of excessive 
compensation practices but represented compensation for the additional 
risk to which executives' wealth was exposed.\355\ The study

[[Page 37763]]

suggests that at financial institutions, compensation was the result of 
efficient contracting between managers and shareholders. The study did 
not find support for the view that compensation determined risk-taking 
and ultimately led to the failure of many institutions.
---------------------------------------------------------------------------

    \354\ See Fahlenbrach, R., Prilmeier, R., Stulz, R. 2012. This 
Time Is the Same: Using Bank Performance in 1998 to Explain Bank 
Performance during the Recent Financial Crisis. Journal of Finance 
67, 2139-2185. The paper examines whether inherent business models 
or/and culture drive certain banks to perform worse during crises. 
The study documents that banks that performed poorly, performance 
measured in terms of stock returns, after Russia's default in 1998 
were also likely to perform poorly during the recent financial 
crisis. These banks had greater degrees of leverage, relied more on 
short-term market funding and grew faster during the years leading 
up to both crisis periods. The authors interpret their findings as 
being attributable to differential risk-taking cultures across banks 
that persist over time.
    \355\ See Cheng, I., Hong, H., Scheinkman, J. 2015. Yesterday's 
Heroes: Compensation and Risk at Financial Firms. Journal of Finance 
70, 839-879. The paper examines the link between managerial pay and 
risk taking in the financial industry. Specifically, the paper 
builds upon efficient contracting theory to predict that managers in 
companies facing greater amounts of uncontrollable risk would 
require higher levels of compensation. Given that higher levels of 
uncontrollable risk expose managerial compensation to increased 
risk, risk averse managers require additional compensation for the 
increased risk exposure. Using various measures of arguably 
uncontrollable company risk, such as lagged risk measures and risk 
measures when the company had an IPO, the authors find a positive 
relation between current compensation and historical measures of 
risk. They interpret their results as inherent differences in risk 
among financial companies driving differences in compensation levels 
among these companies.
---------------------------------------------------------------------------

    Taken all together, while there is debate about certain amounts, 
components, and features of incentive-based compensation that 
potentially encourage risk-taking, the existing academic literature 
does not provide conclusive evidence about a specific type of 
incentive-based compensation arrangement that leads to inappropriate 
risk-taking without taking into account other considerations, such as 
firm characteristics or other governance mechanisms. In particular, 
there may be mitigating factors--some more effective than others--that 
allow efficient contracting to develop compensation arrangements for 
managers to align managerial interests with shareholders' interests and 
provide incentives for maximization of shareholder value.
    If it is the case that some institutions are able to contract 
efficiently for compensation arrangements, for any such institution 
that is a covered BD or IA with large balance sheet assets, and if such 
institution does not pose potentially negative externalities on 
taxpayers, the proposed rule may curtail the pay convexity resulting 
from such efficient contracting between managers and shareholders with 
potential unintended consequences. In particular, unintended 
consequences may include curbing risk-taking incentives to a level that 
is lower than what shareholders deem optimal, with consequent negative 
effects on efficiency and shareholder value. These potential negative 
effects on efficiency and shareholder value could manifest themselves 
in a number of ways. For example, the lower-than-optimal level of risk-
taking could affect covered BDs' and IAs' transactions for their own 
accounts as well as operations that involve customers and clients. The 
SEC expects that whether such consequences occur would depend on the 
specific facts and circumstances of each covered BD or IA.
    In addition, the proposed rule may result in losses of managerial 
talent that may migrate from covered institutions to firms in different 
industries or abroad, especially if CEOs have developed, in recent 
decades, general managerial skills that are transferable across firms 
and industries, as some studies assert.\356\ It should be noted, 
however, as the discussion in the Preamble suggests, that some foreign 
regulators (e.g., in UK) have adopted stricter limits on incentive-
based compensation. Thus, some foreign regulators' restrictions on 
incentive-based compensation may limit the likelihood of human capital 
migrating to foreign institutions subject to those restrictions. 
Moreover, given that incentive-based compensation is also designed to 
attract and retain managerial talent, the proposed rule may result in 
an increased level of total compensation to make up for the limits 
imposed to award opportunities, for the decrease in present value of 
the awards that are deferred, or for the increase in the uncertainty 
associated with the fact that managers may not be able to retain the 
compensation awards due to the potential for forfeiture during the 
deferral period and/or clawback during the period following vesting of 
such awards. If these unintended consequences occur, they may 
contribute to reduce the competitiveness of certain U.S. financial 
institutions in their role of intermediation, potentially affecting 
other industries.
---------------------------------------------------------------------------

    \356\ See Custodio, Claudia, Miguel Ferreira, and Pedro Matos. 
2013. Generalists versus Specialists: Lifetime Work Experience and 
Chief Executive Officer Pay. Journal of Financial Economics 108, 
471-492.
---------------------------------------------------------------------------

    On the other hand, for those covered institutions, including BDs 
and IAs with large balance sheets, that do have the potential to 
generate negative externalities, the proposed rule may result in better 
alignment of incentives between managers at these institutions and 
taxpayers and hence may have potential benefits by lowering the 
likelihood of an outcome that may induce negative externalities. 
Lowering the likelihood of negative externalities would be beneficial 
for the long-term health of these institutions, other institutions that 
are interconnected with those covered institutions and, in turn, the 
long-term health of the U.S. economy. The extent of these potential 
benefits, as mentioned above, would depend on specific facts and 
circumstances at the firm level and individual level.
C. Baseline
    The baseline for the SEC's economic analysis of the proposed rule 
includes the current incentive-based compensation practices of those 
covered institutions that are regulated by the SEC--registered broker-
dealers and investment advisers--and the relevant regulatory 
requirements that may currently affect such compensation 
practices.\357\
---------------------------------------------------------------------------

    \357\ When referencing investment advisers, the SEC's economic 
analysis references those institutions that meet the definition of 
investment adviser under section 202(a)(11) of the Investment 
Advisers Act, including any such institutions that may be prohibited 
or exempted from registering with the SEC under the Investment 
Advisers Act and any that are exempt from registration but are 
reporting.
---------------------------------------------------------------------------

1. Covered Institutions
    Section 956(f) limits the scope of the requirements to covered 
institutions with total assets of at least $1 billion. The proposed 
rule defines covered institution as a regulated institution that has 
average total consolidated assets of $1 billion or more. Regulated 
institutions include covered BDs and IAs. Based on their average total 
consolidated assets, the proposed rule further classifies covered 
institutions into three levels: Level 1 covered institutions with 
average total consolidated assets greater than or equal to $250 
billion; Level 2 covered institutions with average total consolidated 
assets greater than or equal to $50 billion, but less than $250 
billion; and Level 3 covered institutions with average total 
consolidated assets greater than or equal to $1 billion, but less than 
$50 billion.
    In the case of BDs and IAs, a Level 1 BD or IA is a covered 
institution with average total consolidated assets greater than or 
equal to $250 billion, or a covered institution that is a subsidiary of 
a depository institution holding company that is a Level 1 covered 
institution. A Level 2 BD or IA is a covered institution with average 
total consolidated assets greater than or equal to $50 billion that is 
not a Level 1 covered institution; or a covered institution that is a 
subsidiary of a depository institution holding company that is a Level 
2 covered institution. A Level 3 BD or IA is a covered institution with 
average total consolidated assets greater than or equal to $1 billion 
that is not a Level 1 covered institution or Level 2 covered 
institution
    Table 1 shows the number of covered BDs and IAs as of December 31, 
2014, sorted by the size of a BD or IA as a covered institution by 
itself, without considering the size of that covered institution's 
parent depository holding company, if any (hereafter, ``unconsolidated 
Level 1,'' ``unconsolidated Level 2,'' and ``unconsolidated Level 3'' 
BDs and

[[Page 37764]]

IAs).\358\ We use 2014 data in our analysis because this is the most 
recent year for which compensation data is available. From FOCUS 
reports, there were 131 BDs with total assets above $1 billion at the 
end of calendar year 2014.\359\ From Item 1(O) of Form ADV the SEC 
estimated that, out of 11,702 IAs registered with the SEC, or reporting 
to the SEC as an exempt reporting adviser, 669 IAs had total assets of 
at least $1 billion as of December 31, 2014, although the SEC lacks 
information that allows it to further classify these IAs as Level 1, 
Level 2, or Level 3 covered institutions.\360\
---------------------------------------------------------------------------

    \358\ The terms ``unconsolidated Level 1 covered institution,'' 
``unconsolidated Level 2 covered institution,'' and ``unconsolidated 
Level 3 covered institution'' used in the SEC's economic analysis 
differ from the terms ``Level 1 covered institution,'' ``Level 2 
covered institution,'' and ``Level 3 covered institution'' as 
defined in the proposed rule.
    \359\ Total assets are taken from FOCUS report, Part II 
Statement of Financial Condition. The assets reported in the FOCUS 
report are required to be consolidated total assets if a BD has 
subsidiaries.
    \360\ Form ADV requires IAs to report consolidated balance sheet 
assets. The 669 number includes 59 IAs that are not registered with 
the SEC but are reporting.

                            Table 1--Number of Broker-Dealers and Investment Advisers
----------------------------------------------------------------------------------------------------------------
                                           Unconsolidated    Unconsolidated    Unconsolidated
               Institution                     Level 1           Level 2           Level 3            Total
----------------------------------------------------------------------------------------------------------------
Broker-dealers (BDs)....................                 7                13               111               131
Investment advisers (IAs)...............               n/a               n/a               n/a               669
----------------------------------------------------------------------------------------------------------------

i. Broker-Dealers
    In 2014, 4,416 unique BDs filed FOCUS reports. Of these 4,416 BDs, 
seven had total assets greater than $250 billion (Level 1 BDs), 13 had 
total assets between $50 billion and $250 billion (unconsolidated Level 
2 BDs), and 111 had total assets between $1 billion and $50 billion 
(unconsolidated Level 3 BDs) in 2014.\361\ As shown in Table 2, these 
unconsolidated Level 3 BDs had total assets equal to $9.6 billion on 
average and $3.7 billion in median; and about 70 percent (78 out of 
111) of them had total assets below $10 billion.
---------------------------------------------------------------------------

    \361\ For purposes of this analysis, the SEC determined the 
unconsolidated level of each BD. For example, if a BD alone had 
total assets between $1 billion and $50 billion at the end of at 
least one calendar quarter in 2014, it was classified in this 
economic analysis as an unconsolidated Level 3 BD. Similarly, if a 
BD alone had total assets between $50 and $250 billion (greater than 
$250 billion) in at least one quarter in 2014, it was classified in 
this economic analysis as an unconsolidated Level 2 (Level 1) BD. 
This classification method differs from the proposed rule. Thus, 
some of the unconsolidated Level 2 and unconsolidated Level 3 BDs 
discussed in this economic analysis may be Level 1 and Level 2 
covered institutions after consolidation and for purposes of the 
proposed rule. Given that an unconsolidated Level 1 BD alone has 
greater than or equal to $250 billion in total assets, an 
unconsolidated Level 1 BD would be a Level 1 covered institution for 
purposes of the proposed rule, regardless of consolidation.

                                        Table 2--Size Distribution of BDs
----------------------------------------------------------------------------------------------------------------
                                                   Mean size ($   Median size ($   Size range ($   Number of BDs
             BD size               Number of BDs     billion)        billion)        billion)     per size range
----------------------------------------------------------------------------------------------------------------
Below $1 billion................           4,285           $0.02          $0.001
$1-$49 billion (Unconsolidated               111             9.6             3.7            <=10              78
 Level 3).......................
                                                                                           10-20              16
                                  ..............  ..............  ..............           20-30               3
                                  ..............  ..............  ..............           30-40              12
                                  ..............  ..............  ..............             >40               2
$50-$250 billion (Unconsolidated              13            90.6            80.3          50-100               9
 Level 2).......................
                                  ..............  ..............  ..............        100-$150               2
                                  ..............  ..............  ..............         150-200               2
                                  ..............  ..............  ..............            >200               0
Over $250 billion (Level 1).....               7           312.3           275.2         250-300               4
                                  ..............  ..............  ..............         300-350               2
                                  ..............  ..............  ..............         350-400               0
                                  ..............  ..............  ..............            >400               1
----------------------------------------------------------------------------------------------------------------

    The SEC's analysis indicates that, in 2014, all of the 
unconsolidated Level 1 and unconsolidated Level 2 BDs were subsidiaries 
of a holding company or parent institution. Of these parent 
institutions, only one was not a depository institution holding 
company. The majority of the unconsolidated Level 3 BDs were also part 
of a larger corporate structure. It should be noted that some parent 
institutions owned more than one BD. Out of the 111 unconsolidated 
Level 3 BDs, 21 BDs were non-reporting, stand-alone institutions (i.e., 
entities that are not part of a larger corporate structure).
    In Table 3, the parent institutions of the affected BDs are 
classified into Level 1, Level 2, or Level 3, based on the ultimate 
parent's total consolidated assets.\362\ As of the end of 2014, there 
were 23 unique Level 1 parents and 9 unique Level 2 parents that owned 
covered Level 1, unconsolidated Level 2, and unconsolidated Level 3 
BDs. An additional 18 unique parents were Level 3 covered institutions, 
and those owned only unconsolidated Level 3 BDs. The SEC was not able 
to classify 29 parent institutions due to the lack of data on their 
total consolidated assets.
---------------------------------------------------------------------------

    \362\ The name of the ultimate parent was obtained using the 
company information in the Capital IQ database. The SEC found total 
assets information for public parents in the Compustat database. 
Total assets information for some of the private parents the SEC 
found in the Capital IQ database.

[[Page 37765]]



                            Table 3--Distribution of BDs by Level Size of the Parent
----------------------------------------------------------------------------------------------------------------
                                                      BD as a subsidiary of a
                                 ---------------------------------------------------------------- BD as a stand-
                                                                                  Parent size n/       alone
                                  Level 1 parent  Level 2 parent  Level 3 parent         a          institution
----------------------------------------------------------------------------------------------------------------
Number of unconsolidated Level 1               7               0               0               0               0
 BDs............................
Number of unique parents........               7  ..............  ..............  ..............  ..............
Number of public parents........               7  ..............  ..............  ..............  ..............
Median BD assets ($ billion)....          $275.2  ..............  ..............  ..............  ..............
Median parent assets ($ billion)        $1,882.9  ..............  ..............  ..............  ..............
Number of unconsolidated Level 2              13               0               0               0               0
 BDs............................
Number of unique parents........              11  ..............  ..............  ..............  ..............
Number of public parents........              11  ..............  ..............  ..............  ..............
Median BD assets ($ billion)....           $80.3  ..............  ..............  ..............  ..............
Median parent assets ($ billion)        $1,702.1  ..............  ..............  ..............  ..............
Number of unconsolidated Level 3              18              11              23              36              23
 BDs............................
Number of unique parents........              14               9              19              29  ..............
Number of public parents........              14               8              17  ..............  ..............
Median BD assets ($ billion)....            $9.5            $4.0            $3.0            $4.4  ..............
Median parent assets ($ billion)          $850.8          $127.7            $9.2             n/a  ..............
                                 -------------------------------------------------------------------------------
    Total number of unique                    23               9              19              29  ..............
     parents....................
                                 -------------------------------------------------------------------------------
    Total number of public                    23               8              17  ..............  ..............
     parents....................
----------------------------------------------------------------------------------------------------------------

    The majority of BDs that were subsidiaries were held by a parent 
registered with the SEC as a reporting institution (i.e., public 
company). All parents of Level 1 BDs and almost all of the parents of 
unconsolidated Level 2 BDs were public companies, while 39 out of the 
71 unique parents of unconsolidated Level 3 BDs were public companies. 
Twenty three BDs were not subsidiaries but stand-alone companies that 
were private Level 3 BDs.
ii. Investment Advisers
    The SEC does not have a precise way of distinguishing among the 
largest IAs because Form ADV requires an adviser to indicate only 
whether it has $1 billion or more in assets on the last day of its most 
recent fiscal year.\363\ In addition, the information contained on Form 
ADV relates only to registered investment advisers and exempt reporting 
advisers, while the proposed rule would apply to all investment 
advisers.\364\ As of December 2014, there were 669 IAs with assets of 
at least $1 billion, of which 129 IAs were affiliated with banking or 
thrift institutions.\365\ For the remaining 540 IAs the SEC does not 
have information on how many of them are stand-alone companies and how 
many are affiliated with non-bank parent companies. Of the 669 IAs, 51 
are dually registered as BDs with the SEC.\366\ Of the 129 IAs 
affiliated with banking or thrift institutions, 39 IAs are affiliated 
with banks and thrifts with $50 billion or more in assets. Of the 39 
IAs, 10 IAs were affiliated with banks and thrift institutions with 
assets between $50 billion and $250 billion; and 23 IAs were affiliated 
with banks and thrift institutions with assets of more than $250 
billion. As Table 4 shows, the 39 IAs have 25 unique parent 
institutions and most of these parent institutions (17) are public 
companies.
---------------------------------------------------------------------------

    \363\ See Item 1.O of Part 1A of Form ADV. As noted above, the 
SEC has not historically examined its regulated entities' use of 
incentive-based employee compensation. In this regard, Form ADV does 
not contain information with respect to such practices.
    \364\ By its terms, the definition of ``covered financial 
institution'' in section 956 includes any institution that meets the 
definition of ``investment adviser'' under the Investment Advisers 
Act, regardless of whether the institution is registered as an 
investment adviser under that Act. Most investment advisers 
(including registered investment advisers, exempt reporting 
advisers, or otherwise) currently do not report to the SEC their 
average total consolidated assets, so the SEC is unable to determine 
with particularity how many have average total consolidated assets 
greater than or equal to $1 billion and less than $50 billion, 
greater than or equal to $50 billion and less than $250 billion, or 
greater than or equal to $250 billion. The estimates used in this 
section with respect to investment advisers, however, are based on 
data reported by registered investment advisers and exempt reporting 
advisers with the SEC on Form ADV, because the SEC estimates that it 
is unlikely that investment advisers that are prohibited from 
registering with the SEC would be subject to the proposed rule.
    \365\ Form ADV requires an adviser to indicate whether it has a 
``related person'' that is a ``banking or thrift institution,'' but 
does not require an adviser to identify a related person by type 
(e.g., a depository institution holding company). See Item 7 of Part 
1A and Item 7.A of Schedule D to Form ADV. These estimates are 
therefore limited by the information reported by registered 
investment advisers and exempt reporting advisers in their Forms ADV 
and has necessitated manual referencing of the institutions 
specified.
    \366\ Because the data presented below for the effects on BDs 
and IAs are presented separately, in aggregate, they may overstate 
the costs and other economic effects for dual registrants.

   Table 4--Distribution of 39 IAs Affiliated With Level 1 and Level 2 Banks and Thrifts, by Level Size of the
                                                     Parent
----------------------------------------------------------------------------------------------------------------
                                                                              IA as a subsidiary of a
                                                                 -----------------------------------------------
                                                                                                  Parent size n/
                                                                  Level 1 parent  Level 2 parent         a
----------------------------------------------------------------------------------------------------------------
Number of IAs...................................................              23              10               6
Number of unique parents........................................              10               9               6
Number of public parents........................................              10               7               0
----------------------------------------------------------------------------------------------------------------


[[Page 37766]]

2. Current Incentive-Based Compensation Practices
    The SEC does not have information on the incentive-based 
compensation practices of the BDs and IAs themselves. The main reason 
why the SEC lacks such information is that BDs and IAs are generally 
not public reporting companies and as a result they do not provide the 
type of compensation information that a public reporting company would 
file with the SEC as part of its communications with shareholders. 
Notwithstanding these limitations on the data regarding the incentive-
based compensation arrangements at BDs or IAs, when the BDs or IAs are 
subsidiaries of public reporting companies, the SEC has information for 
the public reporting company that is the parent of these BDs and IAs. 
In particular, the information on incentive-based compensation 
practices for named executive officers (``NEOs'') is annually disclosed 
in proxy statements and annual reports filed with the SEC. NEOs 
typically include the principal executive officer, the principal 
financial officer, and three most highly compensated executives.\367\
---------------------------------------------------------------------------

    \367\ For a company that is not a smaller reporting company, 
Item 402(a)(3) of Regulation S-K defines named executive officers 
as: (1) All individuals serving as the company's principal executive 
officer or acting in a similar capacity during the last completed 
fiscal year (PEO), regardless of compensation level; (2) All 
individuals serving as the company's principal financial officer or 
acting in a similar capacity during the last completed fiscal year 
(PFO), regardless of compensation level; (3) The company's three 
most highly compensated executive officers other than the PEO and 
PFO who were serving as executive officers at the end of the last 
completed fiscal year; and (4) Up to two additional individuals for 
whom disclosure would have been provided under the immediately 
preceding bullet point, except that the individual was not serving 
as an executive officer of the company at the end of the last 
completed fiscal year.
---------------------------------------------------------------------------

    Given that it lacks data on the BDs and IAs themselves, for the 
purposes of this economic analysis, the SEC uses data on incentive-
based compensation of the NEOs at the parent institutions, which for 
unconsolidated Level 1 and unconsolidated Level 2 BDs are mostly bank 
holding companies,\368\ as an indirect measure of incentive-based 
compensation practices at the subsidiary level.\369\ The SEC also 
analyzes the incentive-based compensation of public reporting 
institutions with assets between $1 billion and $50 billion, many of 
which are not bank holding companies, because it is possible that size 
may be a determinant of incentive-based compensation arrangements and 
thus the incentive-based compensation of an unconsolidated Level 3 BD 
or IA may be more similar to that of a public reporting institution 
with assets between $1 billion and $50 billion.
---------------------------------------------------------------------------

    \368\ For Level 1 and unconsolidated Level 2 BDs, the SEC's 
analysis indicates that, as of December 2014, two of their 20 unique 
parent institutions are non-bank holding companies (one investment 
management firm and one investment bank/brokerage). For the 39 IAs 
described in Table 4, six of their 25 unique parent institutions are 
not bank holding companies, For unconsolidated Level 3 BDs, 20 of 
the 42 unique parent institutions for which data on their size is 
available are not bank holding companies.
    \369\ It is also possible that the compensation practices 
between Level 1 parent and unconsolidated Level 2 subsidiary (or 
between Level 2 parent and unconsolidated Level 3 subsidiary) may be 
closer to each other than those of Level 1 parent and unconsolidated 
Level 3 subsidiary.
---------------------------------------------------------------------------

    While the SEC utilizes the above-referenced public reporting 
company data, it should be noted that there are a number of caveats 
that may impact the SEC's analysis. First, the incentive-based 
compensation arrangement at the subsidiary level may differ from that 
of the parent level due to either the difference between the size of 
the subsidiary relative to the size of the parent, or because the 
business model of the subsidiary is different from that of the parent. 
More specifically, the incentive-based compensation arrangement of bank 
holding companies may be different than that of BDs or IAs given the 
fundamentally differing natures of the underlying business models and 
the composition of their respective balance sheets. Further, the 
incentive-based compensation practices at a public reporting company 
could be different than those at a non-public reporting company. The 
SEC also does not have information about incentive-based compensation 
of non-NEOs and of those employees included in the definition of 
significant risk-takers under the proposed rule. These caveats mean 
that the SEC's analysis, which is mainly based on data from public bank 
holding companies, may not accurately reflect incentive-based 
compensation practices at BDs and IAs. To address this lack of data, 
the SEC has supplemented its analysis with anonymized supervisory data 
from the Board and the OCC, with limitations to the generalizability of 
the analysis on non-NEOs and significant risk-takers similar to the 
ones discussed above.
i. Named Executive Officers
    Table 5A presents data on the compensation structure of NEOs at 
Level 1, Level 2, and Level 3 parent public reporting institutions of 
unconsolidated Level 1, unconsolidated Level 2, and unconsolidated 
Level 3 BDs as of the end of fiscal year 2014.\370\ In addition to the 
CEO and the CFO, NEOs typically include the chief operating officer 
(``COO''), the general counsel (``GC''), and the heads of business 
units such as wealth management and investment banking. As shown in 
Table 5A, incentive-based compensation is a significant component of 
NEO compensation at parent institutions. It is approximately 90 percent 
of total compensation for Level 1 parent institutions and 85 percent 
for Level 2 parent institutions (median values are also reported in 
parentheses).\371\ Additionally, a sizable fraction of incentive-based 
compensation is in the form of long-term incentive compensation, which 
is mainly awarded in the form of stock, stock options, or debt 
instruments.\372\ The SEC observes that the use of stock options varies 
by size of the parent institution: Stock options represent on average 6 
percent of long-term incentive compensation for Level 1 parents, while 
they represent approximately 20 percent of long-term incentive 
compensation for Level 2 parents.\373\
---------------------------------------------------------------------------

    \370\ Data comes from Compustat's ExecuComp database. Out of 30 
unique Level 1 and Level 2 parent institutions of Level 1, Level 2, 
and Level 3 BDs, compensation data is not available for 16 parent 
institutions.
    \371\ Incentive-based compensation is determined as Total 
compensation as reported in SEC filings--Salary.
    \372\ Long-term incentive compensation is determined using the 
following items from Compustat's ExecuComp database: Total 
compensation as reported in SEC filings--Salary--Bonus--Other annual 
compensation. Short-term incentive compensation is determined as 
Bonus + Other annual compensation.
    \373\ This is consistent with evidence of decreased use of stock 
options in compensation arrangements over the last decade, with 
companies replacing the use of stock options with restricted stock 
units. See Frydman and Jenter, CEO Compensation, Annual Review of 
Financial Economics (2010).

[[Page 37767]]



                    Table 5A--Compensation Structure of BD Parent Institutions by Level Size
----------------------------------------------------------------------------------------------------------------
                                                                  Level 1 parent  Level 2 parent  Level 3 parent
----------------------------------------------------------------------------------------------------------------
Incentive-based compensation as percent of total compensation...       90% (90%)       85% (86%)       83% (87%)
Short-term incentive compensation as percent of total                   15% (0%)         1% (0%)        21% (0%)
 compensation...................................................
Long-term incentive compensation as percent of total                   74% (81%)       85% (86%)       62% (77%)
 compensation...................................................
Option awards as percent of long-term incentive compensation....         6% (0%)       20% (18%)         4% (0%)
Stock awards as percent of long-term incentive compensation.....       68% (69%)       40% (37%)       44% (49%)
Number of NEOs per institution..................................         5.5 (5)         5.3 (5)         5.4 (5)
Number of parent institutions with available compensation data..              10               4               7
----------------------------------------------------------------------------------------------------------------

    Table 5B presents similar statistics for the compensation 
structures of Level 1 and Level 2 parent institutions of IAs that were 
affiliated with banks and thrift institutions with assets of more than 
$50 billion.\374\ The summary statistics for the parent companies of 
IAs mirrors the statistics for the BDs' parent companies: A significant 
portion of NEO compensation is in the form of incentive-based 
compensation, most of which is long-term incentive compensation that 
comes in the form of stock awards.\375\ Both Level 1 and Level 2 IA 
parents exhibit relatively little use of options.
---------------------------------------------------------------------------

    \374\ There is an overlap between the parent institutions of BDs 
and IAs: About half of the IAs' parents are also parents of BDs and 
included in Table 5A.
    \375\ This is not surprising given that approximately half of 
the IAs' parent institutions are also parent institutions of BDs and 
included in Table 5A.

    Table 5B--Compensation Structure of Level 1 and Level 2 IA Parent
                              Institutions
------------------------------------------------------------------------
                                          Level 1 parent  Level 2 parent
------------------------------------------------------------------------
Incentive compensation as percent of           90% (90%)       84% (94%)
 total compensation.....................
Short-term incentive compensation as           20% (28%)         2% (0%)
 percent of total compensation..........
Long-term incentive compensation as            70% (65%)       82% (84%)
 percent of total compensation..........
Option awards as percent of long-term            8% (0%)         9% (0%)
 incentive compensation.................
Stock awards as percent of long-term           71% (73%)       51% (55%)
 incentive compensation.................
Number of NEOs per institution..........         5.2 (5)         5.2 (5)
Number of parent institutions with                     8               5
 available compensation data............
------------------------------------------------------------------------

    Table 6A provides summary statistics for types of incentive-based 
compensation currently awarded by parent institutions of BDs, their 
vesting periods, and the specific measures on which these awards are 
based.\376\ All types of parent institutions use cash in their short-
term incentive compensation. Only 12 percent of Level 1 parent 
institutions, and none of the Level 2 parent institutions, defer short-
term incentive compensation that is awarded in cash only. A significant 
fraction of Level 1 parent institutions awards short-term incentive 
compensation in the form of cash and stock.
---------------------------------------------------------------------------

    \376\ Data for tables 6A through 10B is collected from the 2015 
and 2007 proxy statements, 10-Ks, and 20-Fs of the Level 1, Level 2, 
and Level 3 parent institutions.

            Table 6A--Type and Frequency of Use of Incentive-Based Compensation Awards--Level 1, Level 2, and Level 3 BD Parent Institutions
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                             Short-term incentive compensation                             Long-term incentive compensation
                              --------------------------------------------------------------------------------------------------------------------------
                                  Level 1 parent       Level 2 parent       Level 3 parent      Level 1 parent      Level 2 parent      Level 3 parent
--------------------------------------------------------------------------------------------------------------------------------------------------------
Number of parent institutions  16.................  5..................  13.................  16................  5.................  13.
 with available compensation
 data.
Fraction of total
 compensation:
    CEO......................  25%................  44%................  39%................  52%...............  45%...............  60%.
    Other NEOs...............  27%................  45%................  59%................  50%...............  40%...............  40%.
Award:
    Cash only--percent of      44%................  100%...............  100%...............  6%................  0%................  0%.
     institutions.
        percent that defer     12%................  0%.................  9%.................  6%................  0%................  0%.
         cash.
    Cash & stock--percent of   56%................  0%.................  0%.................  6%................  0%................  9%.
     institutions.
        Avg percent of stock   55%................
         in ST IC.
        Avg deferral for       3 years............
         stock.
    Restricted stock-percent   ...................  ...................  ...................  56%...............  60%...............  100%.
     of institutions.
        Avg percent of LT IC.  ...................  ...................  ...................  36%...............  26%...............  75%.
        Avg vesting period...  ...................  ...................  ...................  3.5 years.........  3.3 years.........  3.4 years.
        Type of vesting:
            percent with pro-  ...................  ...................  ...................  87%...............  100%..............  82%.
             rata.

[[Page 37768]]

 
            percent with       ...................  ...................  ...................  13%...............  0%................  18%.
             cliff.
    Performance stock--        ...................  ...................  ...................  88%...............  80%...............  36%.
     percent of institutions.
        Avg percent of LT IC.  ...................  ...................  ...................  53%...............  42%...............  44%.
        Avg performance        ...................  ...................  ...................  3.7 years.........  3 years...........  2 years.
         period.
            percent with perf  ...................  ...................  ...................  6%................  0%................  100%.
             period <3yrs.
            percent with       ...................  ...................  ...................  14%...............  0%................  0%.
             vesting.
        Avg vesting period...  ...................  ...................  ...................  3.7 years.........
        Type of vesting:
            percent with pro-  ...................  ...................  ...................  100%..............
             rata.
            percent with       ...................  ...................  ...................  0%................
             cliff.
    Options--percent of        0%.................  0%.................  ...................  12%...............  60%...............  18%.
     institutions.
        Avg percent of LT IC.  ...................  ...................  ...................  4%................  20%...............  39%.
        Avg vesting period...  ...................  ...................  ...................  3.5 years.........  3.3 years.........  3 years.
    Notional bonds--percent    0%.................  0%.................  ...................  6%................  0%................  0%.
     of institutions.
        Avg percent of LT IC.  ...................  ...................  ...................  30%...............
        Avg vesting period...  ...................  ...................  ...................  5 years...........
Performance measures:
    EPS or Net income........  44%................  100%...............  31%................  19%...............  50%...............  38%.
    ROA......................  6%.................  40%................  0%.................  19%...............  25%...............  0%.
    ROE......................  44%................  0%.................  31%................  44%...............  50%...............  31%.
    Pre-tax income...........  25%................  0%.................  62%................  6%................  0%................  54%.
    Capital strength.........  31%................  0%.................  0%.................  6%................  0%................  0%.
    Efficiency ratios........  13%................  40%................  0%.................  6%................  0%................  0%.
    Strategic goals..........  19%................  25%................  23%................  13%...............  0%................  23%.
    TSR......................  19%................  25%................  46%................  56%...............  75%...............  54%.
--------------------------------------------------------------------------------------------------------------------------------------------------------

    A significant percentage of long-term incentive compensation of BD 
parent institutions comes in the form of restricted or performance 
stock.\377\ Restricted stock accounts for about 36 percent of long-term 
incentive compensation at Level 1 parent institutions and approximately 
26 percent at Level 2 parent institutions. It has a vesting period of 
approximately 3.5 years. Performance stock awards are more popular: 
Over 80 percent of Level 1 and Level 2 parent institutions employ 
performance stock, which on average accounts for approximately 53 
percent of the long-term incentive compensation of Level 1 parents and 
42 percent of that of Level 2 parents. Performance stock awards are 
frequently evaluated using total shareholder return (``TSR''), return 
on equity (``ROE''), return on assets (``ROA''), earnings per share 
(``EPS''), or a combination of TSR and one or more accounting measures 
of performance over an average of 3.7 years for Level 1 parent 
institutions and 3 years for Level 2 parent institutions. About 14 
percent of Level 1 parent institutions impose deferral after the 
performance period for performance stock. The average deferral period 
for these awards is approximately 4 years.
---------------------------------------------------------------------------

    \377\ Restricted stock includes actual shares or share units 
that are earned by continued employment, often referred to as time-
based awards. Performance stock consists of stock-denominated actual 
shares or share units (performance shares) and grants of cash or 
dollar-denominated units (performance units) earned based on 
performance against predetermined objectives over a defined period.
---------------------------------------------------------------------------

    Consistent with the results in Table 5A above, stock options do not 
appear to be a popular component of incentive-based compensation 
arrangements among Level 1 parent institutions. They are more 
frequently used by Level 2 parent institutions, for which options 
account for approximately 20 percent of long-term incentive 
compensation. One of the Level 1 parents also uses debt instruments as 
a part of NEOs' long-term incentive compensation, which fully vest 
after five years (i.e. cliff vest). Similar results are obtained when 
examining the compensation practices of Level 1 and Level 2 parent 
institutions of IAs, as the summary statistics in Table 6B suggest.

    Table 6B--Type and Frequency of Use of Incentive-Based Compensation Awards--Level 1 and Level 2 IA Parent
                                                  Institutions
----------------------------------------------------------------------------------------------------------------
                                  Short-term incentive  compensation         Long-term incentive compensation
                              ----------------------------------------------------------------------------------
                                  Level 1 parent       Level 2 parent       Level 1 parent      Level 2 parent
----------------------------------------------------------------------------------------------------------------
Number of parent institutions  10.................  6..................  10.................  6.
 with available compensation
 data.
Fraction of total
 compensation:
    CEO......................  23%................  26%................  64%................  63%.
    Other NEOs...............  27%................  27%................  58%................  59%.

[[Page 37769]]

 
Award:
    Cash only--percent of      60%................  83%................  0%.................  0%.
     institutions.
        percent that defer     10%................  0%.................  0%.................  0%.
         cash.
    Cash & stock--percent of   40%................  17%................  10%................  17%.
     institutions.
        Avg percent of stock   50%................
         in ST IC.
        Avg deferral for       3 years............
         stock.
    Restricted stock--percent  ...................  ...................  80%................  67%.
     of institutions.
        Avg percent of LT IC.  ...................  ...................  51%................  30%.
        Avg vesting period...  ...................  ...................  3.5 years..........  3.8 years.
Type of vesting:
            percent with pro-  ...................  ...................  100%...............  100%.
             rata.
            percent with       ...................  ...................  0%.................  0%.
             cliff.
    Performance stock--        ...................  ...................  80%................  100%.
     percent of institutions.
        Avg percent of LT IC.  ...................  ...................  42%................  56%.
        Avg performance        ...................  ...................  3.9 years..........  2.6 years.
         period.
            percent with perf  ...................  ...................  13%................  0%.
             period <3yrs.
            percent with       ...................  ...................  13%................  0%.
             vesting.
        Avg vesting period...  ...................  ...................  4 years............
Type of vesting:
            percent with pro-  ...................  ...................  100%...............
             rata.
            percent with       ...................  ...................  0%.................
             cliff.
    Options--percent of        0%.................  0%.................  10%................  50%.
     institutions.
        Avg percent of LT IC.  ...................  ...................  25%................  28%.
        Avg vesting period...  ...................  ...................  4 years............  3.2 years.
Performance measures:
    EPS or Net income........  60%................  67%................  20%................  50%.
    ROA......................  10%................  17%................  20%................  17%.
    ROE......................  40%................  33%................  60%................  67%.
    Pre-tax income...........  10%................  0%.................  0%.................  0%.
    Capital strength.........  30%................  0%.................  10%................  17%.
    Efficiency ratios........  30%................  17%................  10%................  17%.
    Strategic goals..........  20%................  17%................  20%................  17%.
    TSR......................  30%................  17%................  50%................  17%.
----------------------------------------------------------------------------------------------------------------

    Table 7A reports whether incentive-based compensation of NEOs at 
Level 1, Level 2, and Level 3 parent institutions of BDs is deferred or 
subject to clawback, forfeiture, and certain prohibitions.\378\
---------------------------------------------------------------------------

    \378\ From the disclosures provided by reporting companies on 
clawback, forfeiture and certain prohibitions, the SEC is able to 
establish whether a reporting company currently uses policies that 
are in line with the proposed rule, but was not able to establish 
compliance with certainty.

   Table 7A--Current Deferral, Clawback, Forfeiture and Certain Prohibitions for NEOs at Level 1, Level 2, and
                                         Level 3 BDs Parent Institutions
----------------------------------------------------------------------------------------------------------------
                                                                  Level 1 parent  Level 2 parent  Level 3 parent
----------------------------------------------------------------------------------------------------------------
Number of parent institutions with available compensation data..              16               5              13
Number of NEOs:
    Total number of NEOs........................................             104              24              66
    Average number of NEOs per institution......................               6               5               5
Deferred compensation:
    Institutions with deferred compensation.....................            100%             80%            100%
Average percent of deferred compensation:
        CEO.....................................................             75%             52%             65%
        Other NEOs..............................................             73%             49%             43%
    Average number of years deferred............................             3.5             2.6             3.3
Type of compensation deferred:
    Institutions with cash......................................             19%             25%              8%
    Institutions with stock.....................................            100%            100%            100%
    Institutions with bonds.....................................              6%             N/A              8%
Clawback and forfeiture:
    Institutions with clawback..................................            100%             80%             92%
    Institutions with forfeiture................................            100%             60%             85%
Prohibitions:
    Institutions prohibiting hedging............................             75%             60%             62%

[[Page 37770]]

 
    Institutions prohibiting volume-driven incentive-based                   N/A             N/A             N/A
     compensation...............................................
    Institutions prohibiting acceleration of payments except in              70%             14%              9%
     case of death and disability...............................
Maximum incentive-based compensation:
    Average percent.............................................            155%            190%            134%
Risk Management:
    Institutions with Risk Committees...........................            100%             67%             62%
    Institutions with fully independent Compensation Committee..             93%             88%             83%
    Institutions where CROs review compensation packages........           31.3%             20%             15%
----------------------------------------------------------------------------------------------------------------

    In general, the SEC's analysis of the compensation information 
disclosed in proxy statements and annual reports by parent institutions 
of covered BDs suggests that NEO compensation practices at most of the 
parent institutions are in line with the main requirements and 
prohibitions in the proposed rule. This may not be surprising given 
that the baseline already reflects a regulatory response to the 
financial crisis.\379\ For example, all Level 1 parents and 80 percent 
of Level 2 parents of BDs require some form of deferral of incentive-
based executive compensation. The average Level 1 parent institution 
defers 75 percent of incentive-based compensation awarded to CEOs and 
73 percent awarded to other NEOs, which is above the minimum deferral 
amount that would be required by the proposed rule. In a similar vein, 
an average of 52 percent of incentive-based compensation awarded to 
CEOs and 49 percent awarded to other NEOs is deferred at Level 2 parent 
institutions, similar to what would be required by the proposed rule. 
The length of the deferral period at Level 1 and Level 2 parent 
institutions is also currently in line with what would be required by 
the proposed rule: On average, 3.5 years for NEOs at Level 1 parent 
institutions and approximately 3 years for those at Level 2 parent 
institutions.
---------------------------------------------------------------------------

    \379\ See, 2010 Federal Banking Agency Guidance, available at: 
http://www.federalreserve.gov/newsevents/press/bcreg/20100621a.htm.
---------------------------------------------------------------------------

    Regarding the type of incentive-based compensation that is being 
deferred, both Level 1 and Level 2 parent institutions defer equity-
based compensation. One of the Level 1 parent institutions uses debt 
instruments as incentive-based compensation and defers it as well. Only 
a fraction of them (20 percent of Level 1 and 25 percent of Level 2 
parent institutions), however, currently defer incentive-based 
compensation in cash; the proposed rule would require deferral of 
substantial portions of both cash and equity-like instruments for 
senior executive officers and significant risk-takers at Level 1 and 
Level 2 covered institutions. Thus, for both Level 1 and Level 2 parent 
institutions the current composition of their deferred compensation 
appears to conform to the proposed rule requirements with respect to 
equity-like instruments, but only a few Level 1 and Level 2 parent 
institutions appear to conform to the proposed rule requirements with 
respect to deferral of cash.
    Some of the other requirements and prohibitions for Level 1 and 
Level 2 covered institutions in the proposed rule are also currently in 
place at the parent institutions of covered BDs. For example, all of 
the Level 1 parent institutions and a large majority of Level 2 parent 
institutions require that the incentive-based compensation awards of 
NEOs be subject to clawback and forfeiture provisions. The frequency of 
the use of clawback and forfeiture by Level 1 and Level 2 parent 
institutions is higher than that reported by a commenter \380\ based on 
the results of a study.\381\ The commenter did not specify, however, 
when the study was done, nor the number and type of companies covered 
by the study.
---------------------------------------------------------------------------

    \380\ All references to commenters in this economic analysis 
refer to comments received on the 2011 Proposed Rule.
    \381\ See comment letter from Financial Services Roundtable (May 
31, 2011). The Roundtable conducted a study of a portion of its 
membership. Data was collected on the risk management strategies and 
the procedures for determining compensation since 2008.
---------------------------------------------------------------------------

    A majority of parent institutions also have prohibitions on 
hedging.\382\ Consistent with the proposed prohibition of relying 
solely on relative performance measures when awarding incentive-based 
compensation, all of the Level 1 and Level 2 parent institutions 
currently use a mix of absolute and relative performance measures in 
their incentive-based compensation arrangements. Additionally, most 
Level 1 parent institutions prohibit acceleration of compensation 
payments except in the cases of death or disability, whereas very few 
Level 2 parent institutions do that. The average maximum incentive-
based compensation opportunity is 155 percent of the target amount for 
Level 1 parent institutions and 190 percent for Level 2 parent 
institutions, which is above what would be permitted by the proposed 
rules. In the SEC's analysis of the compensation disclosure, the SEC 
did not find any mention about prohibition of volume-driven incentive-
based compensation as would be proposed by the rule.
---------------------------------------------------------------------------

    \382\ The proposed rule would prohibit covered institutions from 
purchasing hedging instruments on behalf of covered persons. The 
statistics regarding hedging prohibitions presented in Table 7A and 
Table 7B, and Table 9A and Table 9B refer to complete prohibition 
regarding the use of hedging instruments by senior executives and 
directors respectively.
---------------------------------------------------------------------------

    Similar results are obtained when analyzing the current practices 
of the Level 1 and Level 2 parent institutions of IAs (Table 7B). All 
IA parent institutions defer NEO compensation, on average, for three 
years. Almost all parent companies subject incentive-based compensation 
of NEOs to clawback and forfeiture and prohibit hedging transactions.

[[Page 37771]]



      Table 7B--Current Deferral, Clawback, Forfeiture and Certain
   Prohibitions for NEOs at Level 1 and Level 2 IA Parent Institutions
------------------------------------------------------------------------
                                          Level 1 parent  Level 2 parent
------------------------------------------------------------------------
Number of parent institutions with                    10               6
 available compensation data............
Number of NEOs:
    Total number of NEOs................              53              32
    Average number of NEOs per                         5               5
     institution........................
Deferred compensation:
    Institutions with deferred                      100%            100%
     compensation.......................
    Average percent of deferred
     compensation:......................
        CEO.............................             77%             69%
        Other NEOs......................             71%             68%
    Average number of years deferred....             3.6             3.3
Type of compensation deferred:..........
    Institutions with cash..............             20%             67%
    Institutions with stock.............            100%            100%
    Institutions with bonds.............              0%               0
Clawback and forfeiture:
    Institutions with clawback..........            100%            100%
    Institutions with forfeiture........            100%             83%
Prohibitions:
    Institutions prohibiting hedging....             90%             67%
    Institutions prohibiting volume-                 N/A             N/A
     driven incentive-based compensation
    Institutions prohibiting                         70%              0%
     acceleration of payments but for
     death and disability...............
Maximum incentive-based compensation:
    Average percent.....................            148%            188%
Risk Management:
    Institutions with Risk Committees...            100%            100%
    Institutions with fully independent              80%             89%
     Compensation Committee.............
    Institutions where CROs review                   50%             33%
     compensation packages..............
------------------------------------------------------------------------

    To examine how the use of the proposed rule's requirements and 
prohibitions has changed since the financial crisis, in Tables 8A and 
8B the SEC reports the use of incentive-based compensation deferral, 
clawback, forfeiture, and some of the rule prohibitions by the Level 1 
and Level 2 parent institutions of BDs and IAs in year 2007, just prior 
to the financial crisis. A comparison with the results in Tables 7A and 
7B shows that just prior to the financial crisis Level 1 and Level 2 
covered institutions deferred less of NEOs' incentive-based 
compensation compared to what they defer nowadays. More importantly, 
the use of clawback and forfeiture in 2007 was far less common than it 
is now: For example, none of these institutions reported using clawback 
arrangements as of year 2007. Additionally, fewer covered institutions 
had risk committees in year 2007.

  Table 8A--Deferral, Clawback, Forfeiture and Certain Prohibitions for
     NEOs at Level 1 and Level 2 BD Parent Institutions in Year 2007
------------------------------------------------------------------------
                                          Level 1 parent  Level 2 parent
------------------------------------------------------------------------
Number of parent institutions with                    16               5
 available compensation data............
Number of NEOs:
    Total number of NEOs................             101              26
    Average number of NEOs per                         6               5
     institution........................
Deferred compensation:
    Institutions with deferred                      100%            100%
     compensation.......................
    Average percent of deferred
     compensation:
        CEO.............................             49%             34%
        Other NEOs......................             51%             28%
    Average number of years deferred....             3.3               3
Type of compensation deferred:
    Institutions with cash..............              0%             40%
    Institutions with stock.............            100%            100%
Clawback and forfeiture:
    Institutions with clawback..........              0%              0%
    Institutions with forfeiture........             27%             40%
Prohibitions:
    Institutions prohibiting hedging....             14%              0%
    Institutions prohibiting volume-                 N/A             N/A
     driven incentive-based compensation
    Institutions prohibiting                         67%             20%
     acceleration of payments except in
     case of death and disability.......
Maximum incentive-based compensation:
    Average percent.....................            186%             N/A
Risk Management:
    Institutions with Risk Committees...             60%             20%

[[Page 37772]]

 
    Institutions with fully independent              93%            100%
     Compensation Committee.............
    Institutions where CROs review                    0%              0%
     compensation packages..............
------------------------------------------------------------------------

    Thus, the analysis suggests that following the financial crisis, 
most Level 1 and Level 2 parent institutions of BDs and IAs have 
adopted to a certain extent some of the provisions and prohibitions 
that would be required by the proposed rule.

  Table 8B--Deferral, Clawback, Forfeiture and Certain Prohibitions for
     NEOs at Level 1 and Level 2 IA Parent Institutions in Year 2007
------------------------------------------------------------------------
                                          Level 1 parent  Level 2 parent
------------------------------------------------------------------------
Number of parent institutions with                    10               5
 available compensation data............
Number of NEOs:
    Total number of NEOs................              53              26
    Average number of NEOs per                         5               5
     institution........................
Deferred compensation:
    Institutions with deferred                      100%            100%
     compensation.......................
    Average percent of deferred
     compensation:
        CEO.............................             45%             44%
        Other NEOs......................             53%             33%
    Average number of years deferred:...             3.3             3.5
Type of compensation deferred:
    Institutions with cash..............             20%             40%
    Institutions with stock.............            100%            100%
Clawback and forfeiture:
    Institutions with clawback..........              0%              0%
    Institutions with forfeiture........             40%             40%
Prohibitions:
    Institutions prohibiting hedging....             20%              0%
    Institutions prohibiting volume-                 N/A             N/A
     driven incentive-based compensation
    Institutions prohibiting                         40%            100%
     acceleration of payments but for
     death and disability...............
Maximum incentive-based compensation
 Risk Management:
    Average percent.....................            223%             N/A
    Institutions with Risk Committees...             60%              0%
    Institutions with fully independent             100%            100%
     Compensation Committee.............
    Institutions where CROs review                    0%              0%
     compensation packages..............
------------------------------------------------------------------------

    Table 9A lists the most frequent triggers for clawback and 
forfeiture, which include some type of misconduct and adverse 
performance/outcome. About 19 percent of Level 1 parent institutions 
use improper or excessive risk-taking as a trigger for forfeiture and 
clawback. About 88 percent of Level 1 parent institutions use 
misconduct, and 75 percent of Level 1 parent institutions also use 
adverse performance as triggers for clawback, similar to the proposed 
rules.

                   Table 9A--Percentage of Level 1, Level 2, and Level 3 BD Parent Institutions by Trigger for Forfeiture and Clawback
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                  Level 1 parents                 Level 2 parents                 Level 3 parents
                                                         -----------------------------------------------------------------------------------------------
                         Trigger                           Forfeiture: %  Clawback: % of   Forfeiture: %  Clawback: % of   Forfeiture: %  Clawback: % of
                                                             of firms          firms         of firms          firms         of firms          firms
--------------------------------------------------------------------------------------------------------------------------------------------------------
Adverse performance/outcome.............................              75              75              20              20               0               9
Misconduct/gross/detrimental conduct....................              88              88              40              60              57              63
Improper/excessive risk-taking..........................              19              19               0               0              14              18
Managerial failure......................................               6               6               0               0               0               0
Restatement/inaccurate reporting........................              19              19              40              60              71              73
Voluntary resignation/retirement........................              13              13               0               0               0               0
Misuse of confidential information/competitive activity.  ..............  ..............  ..............  ..............              29               0
Policy/regulatory breach................................               6               6               0               0               0               0
For-cause termination...................................               6               6               0              20              14               0

[[Page 37773]]

 
Number of parent institutions with available                          16  ..............               5  ..............              13  ..............
 compensation data......................................
--------------------------------------------------------------------------------------------------------------------------------------------------------

    The use of forfeiture and clawback triggers is similar for IA 
parent institutions, as Table 9B shows. A significant number of Level 1 
parent institutions use adverse performance and misconduct as triggers 
for both clawback and forfeiture.

          Table 9B--Triggers for Forfeiture and Clawback of Level 1 and Level 2 IA Parent Institutions
----------------------------------------------------------------------------------------------------------------
                                                          Level 1 parents                 Level 2 parents
                                                 ---------------------------------------------------------------
                     Trigger                       Forfeiture: %  Clawback: % of   Forfeiture: %  Clawback: % of
                                                     of firms          firms         of firms          firms
----------------------------------------------------------------------------------------------------------------
Adverse performance/outcome.....................              80              80              33              33
Misconduct/gross/detrimental conduct............              60              70              50              67
Improper/excessive risk-taking..................              40              40              17              17
Managerial failure..............................               0               0               0              17
Restatement/inaccurate reporting................              10              30              33              50
Misuse of confidential information/competitive                10              10              33              17
 activity.......................................
For-cause termination...........................              10              10              33              17
Number of parent institutions with available                  10  ..............               6  ..............
 compensation data..............................
----------------------------------------------------------------------------------------------------------------

    Some of the provisions of the proposed rule (e.g., prohibition of 
hedging) would apply to covered persons that are non-employee directors 
who receive incentive-based compensation at Level 1 and Level 2 covered 
institutions. Table 10A presents summary statistics on the current 
compensation practices of Level 1, Level 2, and Level 3 parent public 
institutions of BDs with respect to their non-employee directors. The 
data shows that most of the Level 1 parent institutions and all of the 
Level 2 parent institutions provide incentive-based compensation to 
their non-employee directors, and this compensation comes mainly in the 
form of deferred equity. Additionally, a large percentage of both Level 
1 and Level 2 parents prohibit hedging by non-employee directors.

                 Table 10A--Incentive-Based Compensation of Non-Employee Directors of BD Parents
----------------------------------------------------------------------------------------------------------------
                                        Level 1 parents            Level 2 parents           Level 3 parents
----------------------------------------------------------------------------------------------------------------
Percentage of institutions with    77%......................  100%....................  100%.
 non-employee directors receiving
 IBC.
Non-employee director IBC as       56%......................  46%.....................  55%.
 percentage of total compensation.
Type of IBC:
    Deferred equity..............  90%......................  100%....................  100%.
    Options......................  10%......................  50%.....................  8%.
Vesting (average number of years)  2.6 years................  2.3 years...............  1.9 years.
Percentage of institutions         70%......................  100%....................  25%.
 prohibiting hedging by non-
 employee directors.
----------------------------------------------------------------------------------------------------------------

    The analysis of non-employee director compensation at the Level 1 
and Level 2 parent institutions of IAs in Table 10B shows similar 
results: In all of the parent institutions non-employee directors 
receive incentive-based compensation and a significant fraction of 
parent institutions prohibit hedging transactions related to incentive-
based compensation.

 Table 10B--Incentive-Based Compensation of Non-Employee Directors of IA
                                 Parents
------------------------------------------------------------------------
                                     Level 1               Level 2
------------------------------------------------------------------------
Percentage of institutions    100%................  100%.
 with non-employee directors
 receiving IBC.
Non-employee director IBC as  56%.................  46%.
 percentage of total
 compensation.
Type of IBC:
    Deferred equity.........  90%.................  100%.
    Options.................  0%..................  17%.
Vesting (average number of    1.5 years...........  1.6 years.
 years).
Percentage of institutions    78%.................  83%.
 prohibiting hedging by non-
 employee directors.
------------------------------------------------------------------------


[[Page 37774]]

ii. Executives Other Than Named Executive Officers
    While the above statistics are based on publicly disclosed 
information on compensation for the five most highly compensated 
executive officers at parent institutions, the proposed rule would 
apply to any executive officer, employee, director or principal 
shareholder (covered persons) who receives incentive-based 
compensation. Thus, the data presented above may not be representative 
for non-NEOs. To provide some evidence on the current incentive-based 
compensation arrangements of non-NEOs, the SEC uses anonymized 
supervisory data from the Board. It should be noted that the 
composition of the supervisory data sample could be different than that 
of the Level 1 and Level 2 parent institutions analyzed above. To 
alleviate this potential selection problem, Table 10 compares NEO and 
non-NEO compensation arrangements only for the supervisory data sample. 
Also, the supervisory data comes from banks, while the data above is 
from bank holding companies. Because there may be differences in 
incentive-based compensation arrangements and policies at the bank 
level and the bank holding company level, the supervisory data analysis 
could yield different results compared to the results presented in the 
tables above.
    Since the supervisory data does not identify NEOs and non-NEOs but 
identifies the managerial position of each executive, the SEC uses an 
indirect approach to separate the two groups of executives. From the 
proxy statements of Level 1 and Level 2 parent institutions, the SEC 
identifies the executives that are most often included in the 
definition of NEOs, in addition to the CEO and the CFO. These 
executives are the COO, the GC, and often the heads of wealth 
management or investment banking. The SEC then classifies these 
executives as NEOs and any other executive as non-NEO. Table 11 
presents summary statistics for NEOs and non-NEOs based on the 
supervisory data.
    Similar to NEOs, non-NEOs tend to have a significant fraction of 
long-term incentive compensation in the form of restricted stock units 
(``RSUs'') and performance stock units (``PSUs'') that is deferred on 
average for about three years. Only 36 percent of institutions in the 
sample used cash as incentive-based compensation for non-NEOs and a 
significant fraction (on average about 50 percent across institutions 
that use cash as incentive-based compensation) of the cash incentive-
based compensation is deferred. Similarly, 45 percent of the deferred 
incentive-based compensation for non-NEOs was in the form of restricted 
stock and 54 percent was in the form of performance share units. Fifty 
percent of the institutions in the sample used options as incentive-
based compensation for non-NEOs, with average vesting period of 
approximately 3.7 years.

                   Table 11--Existing Compensation Arrangements for NEO and Non-NEO Executives
----------------------------------------------------------------------------------------------------------------
                                              Non-NEOs                                    NEOs
----------------------------------------------------------------------------------------------------------------
Number of institutions with   14......................................  14.
 available compensation data.
Number of executives........  112.....................................  50.
ST IC/total IC..............  41%.....................................  40%.
Deferred IC/total IC........  60%.....................................  64%.
Options/total IC............  12%.....................................  13%.
percent of institutions with  70%.....................................  70%.
 options.
Deferred IC subject to        57%.....................................  61%.
 clawback and forfeit/
 deferred IC.
Types of IC compensation
 used:
Cash:
    percent of institutions   36%.....................................  36%.
     using cash.
    cash as percent of        48%.....................................  50%.
     deferred IC.
    length of vesting.......  3 years.................................  3 years.
    type of vesting.........  40% immediate, 60% pro-rata.............  40% immediate, 60% pro-rata.
RSUs:
    percent of institutions   64%.....................................  64%.
     using RSUs.
    RSU as percent of         45%.....................................  47%.
     deferred IC.
    length of vesting.......  3.2 years...............................  3.2 years.
    type of vesting.........  11% immediate, 89% pro-rata.............  11% immediate, 89% pro-rata.
PSUs:
    percent of institutions   64%.....................................  64%.
     using PSUs.
    PSU as percent of         54%.....................................  56%.
     deferred IC.
    performance period......  3 years.................................  3 years.
    length of vesting.......  3 years.................................  3 years.
    type of vesting.........  78% immediate, 22% pro-rata.............  78% immediate, 22% pro-rata.
Options:
    percent of institutions   50%.....................................  50%.
     using options.
    Options as percent of     18%.....................................  19%.
     deferred IC.
    length of vesting.......  3.7 years...............................  3.7 years.
    type of vesting.........  100% pro-rata...........................  100% pro-rata.
----------------------------------------------------------------------------------------------------------------

iii. Significant Risk-Takers
    The proposed rule requirements also would apply to significant 
risk-takers who receive incentive-based compensation. Because data on 
the compensation of significant risk-takers is not publicly available, 
the SEC relies on bank supervisory data from the OCC to provide some 
evidence on the current practices regarding significant risk-taker 
compensation at covered institutions. In the OCC anonymized data, banks 
identify material risk-takers and specific compensation arrangements 
for them. The definition of a material risk-taker is similar, but not 
identical, to that of a significant risk-taker in the proposed rule. 
Based on supervisory data from three Level 2 covered institutions, it 
seems that the incentive-based compensation of material risk-takers is 
subject to deferral, clawback and forfeiture. The fraction of 
incentive-based compensation that is subject to deferral depends on the 
size of the compensation a material risk-taker

[[Page 37775]]

receives. As Table 12 suggests, the percentage deferred varies, with 
some exceptions, from 40 percent to 60 percent. The average length of 
the deferral period is three years.

            Table 12--Deferral Policy for Material Risk-Takers at Three Level 2 Covered Institutions
----------------------------------------------------------------------------------------------------------------
                                                                                                     Length of
             Institutions                     Deferral percent            Forfeiture/clawback        deferral
                                                                                                      (years)
----------------------------------------------------------------------------------------------------------------
Institution 1........................  40%-60%......................  Yes.......................               3
Institution 2........................  40%..........................  Yes.......................               3
Institution 3........................  10%-40%, 40% if bonus          Yes.......................               3
                                        >$750,000.
----------------------------------------------------------------------------------------------------------------

    Due to the lack of data, the SEC is unable to shed light on current 
significant risk-taker compensation practices with respect to some of 
the other proposed rule requirements such as the use of hedging or the 
type of compensation that is being deferred (cash vs. stock vs. 
options). In addition, the data is based on information from only three 
Level 2 covered institutions. It is also worth noting that the OCC data 
is at the bank subsidiary level, not the depository institution holding 
company level. Thus, it is possible that the features of the 
compensation of significant risk-takers at the bank subsidiary level 
may not be representative of the compensation of significant risk-
takers at BDs and IAs.
iv. Covered Persons at Subsidiaries
    Economic theory suggests that, in large, complex, and 
interconnected financial institutions that are perceived to receive 
implicit government guarantee, managers of these institutions could 
have the incentive to take on more risk than they would have taken had 
there been no implicit government backstops, thus creating negative 
externalities for taxpayers. As discussed above, the proposed rule 
could decrease the likelihood of such negative externalities. To the 
extent that certain BDs and IAs pose high risk that may lead to 
externalities, covered persons likely would therefore include those 
individuals who, by virtue of receiving incentive-based compensation, 
are in a position of placing significant risks.
    Under the proposed rule, senior executive officers and significant 
risk-takers of BDs and IAs that are covered institutions would be 
considered covered persons. The proposed rule would require 
consolidation of subsidiaries of BHCs that are themselves covered 
institutions for the purpose of applying certain rule requirements and 
prohibitions to covered persons. As a result of this proposed 
consolidation, covered persons employed at BDs and IAs would be subject 
to the same requirements as the covered persons of their parent 
institutions, even though the BDs and IAs may be of a smaller size, and 
hence otherwise treated at a lower level, than their parent 
institutions. This proposed consolidation would significantly affect 
unconsolidated Level 3 BDs because most of them are held by Level 1 and 
Level 2 covered institutions, as well as Level 3 IAs that are held by 
Level 1 and Level 2 covered institutions. The proposed consolidation 
would also affect unconsolidated Level 2 BDs and IAs that are held by 
Level 1 covered institutions because those BDs and IAs will also become 
Level 1 covered institutions for the purposes of the rule.
    As of December 2014, there were 29 unconsolidated Level 3 BDs whose 
parent institutions are Level 1 and Level 2 institutions (Table 3); 
only one of those parent institutions was not a covered institution as 
defined by the rule. Additionally, there were 38 unconsolidated Level 3 
BDs whose parents were private institutions; while it is possible that 
some of these may be Level 1 or Level 2 institutions, the SEC lacks 
data to determine their size. With respect to the proposed rule 
requirements, the current compensation arrangements of NEOs of Level 3 
parent institutions exhibit some important differences compared to 
Level 1 and Level 2 parent institutions. For example, Level 3 parent 
institutions typically defer a smaller fraction of NEOs' incentive-
based compensation (Table 7A), defer cash less frequently (Table 7A), 
and tend to use more options as part of their incentive-based 
compensation arrangements (Table 6A), compared to Level 1 and Level 2 
parent institutions. On the other hand, Level 3 covered institutions, 
like Level 1 and Level 2 covered institutions, tend to apply forfeiture 
and clawback and prohibit hedging (Table 7A).
    The proposed rule also would require consolidation with respect to 
certain significant risk-takers. Under the proposed definition of 
significant risk-taker, employees of a subsidiary that could put 
substantial capital of the parent institution at risk would be deemed 
significant risk-takers of the parent institution, and the proposed 
rule requirements would apply to them in the same manner as the 
significant risk-taker at their parent institutions. Because data on 
the compensation of significant risk-takers is not publicly available, 
the SEC relies on bank supervisory data from the OCC regarding the 
current compensation practices for significant risk-takers at Level 3 
financial institutions; the SEC does not have data on the compensation 
arrangements at Level 1 and Level 2 institutions. Table 13 shows 
summary statistics for the compensation arrangements of significant 
risk-takers at Level 3 covered institutions. The compensation 
arrangements of significant risk-takers of Level 3 covered institutions 
seem similar to those of NEOs of Level 3 covered institutions. It is 
also worth noting that the OCC data is at the bank subsidiary level, 
not the depository institution holding company level. Thus, it is 
possible that the features of the compensation of significant risk-
takers at the bank subsidiary level may not be representative of the 
compensation of significant risk-takers at BDs and IAs.

Table 13--Existing Compensation Arrangements for Significant Risk-Takers
                     of Level 3 Covered Institutions
------------------------------------------------------------------------
                                        Significant risk-takers
------------------------------------------------------------------------
Number of institutions with    5.
 available compensation data.

[[Page 37776]]

 
ST IC/total IC...............  77%.
Deferred IC/total IC.........  23%.
Deferred IC subject to         89%.
 clawback and forfeit/
 deferred IC.
Types of IC compensation
 used:
Cash:
    percent of institutions    80%.
     using cash.
    cash as percent of         22%.
     deferred IC.
    length of vesting........  0.33 years.
    type of vesting..........  100% pro-rata.
RSUs:
    percent of institutions    100%.
     using RSUs.
    RSU as percent of          31%.
     deferred IC.
    length of vesting........  3 years.
    type of vesting..........  40% immediate, 60% pro-rata.
PSUs:
    percent of institutions    80%.
     using PSUs.
    PSU as percent of          12%.
     deferred IC.
    performance period.......  1.9 years.
    length of vesting........  3 years.
    type of vesting..........  80% immediate, 20% pro-rata.
Options:
    percent of institutions    20%.
     using options.
    Options as percent of      25%.
     deferred IC.
    length of vesting........  NA.
    type of vesting..........  NA.
------------------------------------------------------------------------

3. Regulatory Baseline
    The existing regulatory environment, especially after the financial 
crisis of 2007-2008, is also relevant to the current compensation 
practices of covered institutions and the effects of the proposed 
rulemaking. Several guidance and codes that specifically target 
incentive-based compensation have been adopted by various financial 
regulators that may also apply to some BDs and IAs. Some of those 
prescribe compensation practices and suggest prohibitions that are 
similar to the requirements and prohibitions in the proposed rules.
i. Guidance on Sound Incentive Compensation Policies
    In June 2010, the U.S. Federal Banking Agencies \383\ adopted the 
Guidance on Sound Incentive Compensation Policies.\384\ The guidance 
applies to banking institutions and, because most of the parents of 
Level 1 and Level 2 BDs are bank holding companies subject to the 
guidance, its principles may apply to these BDs as well if the 
compensation structures at subsidiaries are similar to those at the 
parent institutions and the parent institution determines to implement 
relatively uniform incentive-based compensation policies for the 
consolidated institution. The guidance may also apply to the 39 IAs 
that are affiliated with banks and thrift institutions with assets of 
more than $50 billion.
---------------------------------------------------------------------------

    \383\ The Federal Banking Agencies, as of 2010, were the Board, 
OCC, FDIC, and Office of Thrift Supervision.
    \384\ See, 2010 Federal Banking Agency Guidance, available at: 
http://www.federalreserve.gov/newsevents/press/bcreg/20100621a.htm.
---------------------------------------------------------------------------

    The guidance is designed to prevent incentive-based compensation 
policies at banking institutions from encouraging imprudent risk-taking 
and to aid in the development of incentive-based compensation policies 
that are consistent with the safety and soundness of the institution. 
It has three key principles providing that compensation arrangements at 
a banking institution should: (a) Provide employees with incentives 
that appropriately balance risk and reward; (b) be compatible with 
effective risk management and controls; and (c) be supported by strong 
corporate governance, including active and effective oversight by the 
institution's board of directors. Similar to the proposed rules, this 
guidance applies to senior executives and other employees who, either 
individually or as a part of a group, have the ability to expose the 
relevant banking institution to a material level of risk. The guidance 
suggests several methods of balancing risk and rewards: Risk adjustment 
of awards; deferral of payment; longer performance periods; and reduced 
sensitivity to short-term performance.
ii. UK Prudential Regulatory Authority Remuneration Code
    The SEC notes that for BDs and IAs whose parents are regulated by 
foreign authorities, the foreign regulatory framework with respect to 
incentive-based compensation may also be relevant for compliance with 
the proposed rules.\385\ For example, in 2010, the UK PRA adopted four 
remuneration codes that apply to banks and investment firms and share 
important similarities with the proposed rules.\386\ For instance, the 
SYSC 19A remuneration code imposes a deferral of at least 40 percent 
for not less than 3-5 years. For higher earners, at least 60 percent 
has to be deferred. The code applies to senior management, risk takers, 
staff engaged in control functions, and any employee receiving 
compensation that takes them into the same income bracket as senior 
management and risk takers, whose professional activities have a 
material impact on the firm's risk profile. The code also requires that 
at least 50 percent of any bonus must be made in shares, share-linked 
instruments or

[[Page 37777]]

other equivalent non-cash instruments of the firm. These shares should 
be subject to an appropriate retention period. Firms also need to 
disclose details of their remuneration policies at least annually.
---------------------------------------------------------------------------

    \385\ For example, 3 Level 1 and Level 2 BDs have parent 
institutions that are subject to the UK PRA rules.
    \386\ There are four codes: SYSC 19A (covering Deposit Taker and 
Investment firms), SYSC 19B (covering Alternative Investment Fund 
Managers), SYSC 19C--BIPRU (covering Investment firms), and SYSC 19D 
(covering Dual-regulated firms Remuneration Code). See https://www.the-fca.org.uk/remuneration.
---------------------------------------------------------------------------

    In July 2014, the Prudential Regulation Authority (PRA) and 
Financial Conduct Authority (FCA) published two joint consultation 
papers ``aimed at improving individual responsibility and 
accountability in the banking sector.'' \387\ The papers seek feedback 
on proposed changes to the rules for remuneration for UK banks and PRA-
designated investment firms.\388\ The PRA and FCA's new proposed rules 
follow recommendations made by the UK Parliamentary Commission on 
Banking Standards, ``Changing Banking for Good,'' published in June 
2013, and are a response to the major role played by banks in the 
financial crisis in 2007-2008 and allegations of the attempted 
manipulation of LIBOR. Their new proposed rules were deemed necessary 
because the current rule on individual accountability is ``often 
unclear or confused'' \389\ and thus undermines public trust in the 
banking sector and the financial regulators. The PRA and FCA proposed 
that banks defer bonuses for a minimum of 7 years for senior managers 
and 5 years for other material risk-takers. Financial institutions 
would be able to recover variable pay even if it was paid out or vested 
for up to 7 years after the award date.
---------------------------------------------------------------------------

    \387\ See ``Prudential Regulation Authority and Financial 
Conduct Authority Consult on Proposals to Improve Responsibility and 
Accountability in the Banking Sector,'' Press Release by the 
Financial Conduct Authority, (July 30, 2014), available at: https://www.fca.org.uk/news/pra-and-fca-consult-on-proposals-to-improve-responsibility-and-accountability-in-the-banking-sector.
    \388\ See ``Strengthening Accountability in Banking: A New 
Regulatory Framework for Individuals,'' PRA CP14/13, Consultation 
Paper, July 2014, available at: https://www.fca.org.uk/news/cp14-13-strengthening-accountability-in-banking. See also, ``Strengthening 
the Alignment of Risk and Reward: New Remuneration Rules,'' PRA 
CP14/14, Consultation Paper, July 2014, available at: https://www.fca.org.uk/news/cp14-14-strengthening-the-alignment-of-risk-and-reward.
    \389\ See FSA Consultation Paper 14/13: Strengthening 
accountability in banking: a new regulatory framework for 
individuals (https://www.fca.org.uk/news/cp14-13-strengthening-accountability-in-banking).
---------------------------------------------------------------------------

D. Scope of the Proposed Rule
1. Levels of Covered Institutions
    The proposed rule would create a tiered system of covered 
institutions based on an institution's average total consolidated 
assets during the most recent consecutive four quarters.\390\ There are 
three levels of covered institutions: Level 1, Level 2, and Level 3 
covered institutions. Some of the proposed rule requirements (e.g., 
deferral of compensation, forfeiture and clawback) would apply 
differentially to covered institutions based on their size tier, with 
more stringent restrictions on the incentive-based compensation 
arrangements at larger institutions (i.e., Level 1 and Level 2 covered 
institutions). In general, the importance of financial institutions in 
the economy tends to be positively correlated with their size. This is 
apparent from the use of implicit ``too-big-to-fail'' policies by 
governments and central banks, providing support to large financial 
institutions at times of financial crises because of their importance 
to the greater financial system.\391\ In a similar vein, the 2010 
Federal Banking Agency Guidance prescribes stricter compensation rules 
and related risk-management and corporate governance practices for 
large and more complex banking institutions.\392\
---------------------------------------------------------------------------

    \390\ For IAs, the tiered system would be based on year end 
balance sheet assets (excluding non-proprietary assets).
    \391\ See, for example, Frederic Mishkin, Financial 
Institutions.
    \392\ Large banking institutions include, in the case of banking 
institutions supervised by (i) The Board, large, complex banking 
institutions as identified by the Board for supervisory purposes; 
(ii) the OCC, the largest and most complex national banks as defined 
in the Large Bank Supervision booklet of the Comptroller's Handbook; 
(iii) the FDIC, large, complex insured depository institutions 
(IDIs). See, 2010 Federal Banking Agency Guidance, available at: 
http://www.federalreserve.gov/newsevents/press/bcreg/20100621a.htm.
---------------------------------------------------------------------------

    There are various measures developed to estimate the amount of risk 
\393\ posed by an institution to the greater financial system. One 
study finds that the degree of leverage, maturity mismatch and the size 
of the institution are all related to a measure of systemic importance 
and risk.\394\ Another study finds that institution size, degree of 
leverage and covariance of the institution's stock with the market 
during distress are related to the systemic risk contribution of an 
institution.\395\ Moreover, an academic study of the financial crisis 
states that the size of an institution is likely to magnify the impact 
of failure to the entire financial system.\396\ In terms of defining 
systemic importance, bank holding companies with assets over $50 
billion are required to disclose to the Board on an annual basis, three 
indicators related to their systemic risk: Institution size, 
interconnectedness and complexity.\397\
---------------------------------------------------------------------------

    \393\ See Bisias et al. 2012. A Survey of Systemic Risk 
Analytics. Office of Financial Research, Working Paper.
    \394\ See Adrian, T., Brunnermier, M. 2011. COVAR. American 
Economic Review, forthcoming. The paper proposes a measure for 
systemic risk contribution by financial institutions. The forward-
looking measure of systemic risk contribution is significantly 
related to lagged characteristics of financial institutions such as 
size, leverage, and maturity mismatch.
    \395\ See Brownlees, C., Engle, R. 2015. SRISK: A Conditional 
Capital Shortfall Index for Systemic Risk Measurement. Working 
Paper. The paper develops a measure of systemic risk contribution of 
a financial firm. This measure associates systemic risk with the 
capital shortfall a financial institution is expected to experience 
conditional on a severe market decline. The measure is a function of 
the firm's size, degree of leverage and the expected equity loss 
conditional on a market downturn.
    \396\ See French et al. 2010. Squam Lake Report: Fixing the 
Financial System. Princeton University Press.
    \397\ Size is correlated with the two other measures of systemic 
importance, complexity and interconnectedness. See FSOC 2015 Annual 
Report, available at: https://www.treasury.gov/initiatives/fsoc/studies-reports/Documents/2015%20FSOC%20Annual%20Report.pdf.
---------------------------------------------------------------------------

    By setting stricter restrictions on the incentive-based 
compensation arrangements at Level 1 and Level 2 covered institutions, 
the tiered approach could benefit taxpayers. To the extent that 
stricter incentive-based compensation rules are effective at curbing 
inappropriate risk-taking, this could lessen the default likelihood for 
Level 1 and Level 2 covered institutions, thus increasing the 
likelihood that taxpayers would not have to incur costs to rescue 
important institutions. Moreover, if the stricter incentive-based 
compensation rules lower the likelihood of default for Level 1 and 
Level 2 covered institutions, the likelihood of default for smaller 
institutions could decrease as well, to the extent that smaller 
institutions are exposed to counterparty risks due to their connection 
with larger Level 1 and Level 2 covered institutions.
    Consolidation requirements aside, the tiered approach also would 
not impose as great a compliance burden on smaller Level 3 covered 
institutions for which the proposed rule requirements on deferral, 
forfeiture and clawback, and some other prohibitions and requirements 
do not apply. To the extent that compliance costs have a fixed 
component that may have a disproportionate impact on smaller 
institutions, excluding Level 3 covered institutions from more 
burdensome requirements would not place them at a competitive 
disadvantage compared to Level 1 and Level 2 covered institutions. 
Moreover, to the extent that executives' incentives become distorted 
due to the implicit government guarantee, this is less likely to be the 
case for Level 3 covered institutions due to their relatively smaller 
size. Thus, the potential benefits of the proposed rule may be less 
substantial for smaller covered institutions since such institutions 
are less likely to be in a

[[Page 37778]]

position to take risks that may lead to externalities.
    However, to the extent that the stricter proposed requirements for 
incentive-based compensation arrangements at Level 1 and Level 2 
covered institutions induce less than optimal risk-taking incentives 
for covered persons from shareholders' point of view, this could result 
in a decrease in firm value and hence lower returns for the 
shareholders of these institutions. Additionally, the stricter 
requirements for Level 1 and Level 2 covered institutions could make it 
more difficult to attract and retain human capital, thus creating 
competitive disadvantages in the labor market for these institutions. 
If these institutions become disadvantaged due to their stricter 
compensation requirements, they might be forced to increase overall 
compensation to be able to compete for managerial talent with firms 
that are not affected by the proposed rules.
    As discussed above, besides an institution's average total 
consolidated assets, other indicators (for example, the size of that 
institution's open counterparty positions in a market) not perfectly 
correlated with size could be a proxy for the importance of financial 
institutions to the financial sector and the broader economy. If size 
is not a good proxy for the importance of a financial institution, then 
the proposed rule would likely pose a disproportionate compliance 
burden on larger institutions while not covering institutions that may 
be more significant to the overall financial system under different 
proxies for importance.
    The proposed thresholds for identifying Level 1 covered 
institutions (over $250 billion) and Level 2 covered institutions 
(between $50 billion and $250 billion) are similar to those used by 
banking regulators in other contexts. For example, the $250 billion is 
used by Basel III as a threshold to identify core banks that must adopt 
the Basel standards; and the $50 billion threshold is used in a number 
of sections of the Dodd-Frank Act.\398\ The use of these two thresholds 
might place a higher compliance burden on institutions that, are close 
to, but just above the threshold compared to institutions that are 
close, but just below the threshold. For example, a BD that has a size 
of $49 billion is likely to be similar in many aspects to a BD that has 
a size of $51 billion. Yet, with the current cutoff points, the former 
would not be subject to deferral, forfeiture and clawback, and other 
prohibitions in the proposed rule, while the latter would be.
---------------------------------------------------------------------------

    \398\ For example, sections 165 and 166 of the Dodd-Frank Act 
require the Board to establish enhanced prudential standards for 
nonbank financial companies supervised by the Board and bank holding 
companies with total consolidated assets of $50 billion or more. In 
prescribing more stringent prudential standards, the Board may, on 
its own or pursuant to a recommendation by the Council in accordance 
with section 115, differentiate among companies on an individual 
basis or by category, taking into consideration their capital 
structure, riskiness, complexity, financial activities (including 
the financial activities of their subsidiaries), size, and any other 
risk-related factors that the Board deems appropriate.
---------------------------------------------------------------------------

    By covering various types of financial institutions (e.g., banks, 
BDs, IAs, thrifts, etc.) with at least $1 billion in assets, section 
956 and the proposed rule implicitly assume that larger institutions 
pose higher risks, including risks that may impact the financial system 
at large. This assumption may not hold true for certain institutions. 
For example, in the case of BDs and IAs, which may have a much narrower 
scope of activities than a comparably sized commercial bank, the 
narrower range of activities could limit their impact on the overall 
financial system. On the other hand, larger BDs and IAs may pose higher 
risks than smaller BDs and IAs. Also, at least one study has suggested 
that the interconnectedness of financial institutions generally could 
affect multiple financial institutions in a crisis and impact otherwise 
unrelated parts of the larger financial system.\399\ Another study 
asserts that financial institutions, including broker-dealers, have 
become highly interrelated and less liquid in the past decade, thus 
increasing the level of risk in the financial sector.\400\
---------------------------------------------------------------------------

    \399\ See, for example, Bisias D., M. Flood, A.W. Lo, and S. 
Valavanis, 2012. A Survey of Systemic Risk Analytics. Office of 
Financial Research, Working paper, available at: https://www.treasury.gov/initiatives/wsr/ofr/Documents/OFRwp0001_BisiasFloodLoValavanis_ASurveyOfSystemicRiskAnalytics.pdf. 
On page 9, the authors argue that ``In a world of interconnected and 
leveraged institutions, shocks can propagate rapidly throughout the 
financial network, creating a self-reinforcing dynamic of forced 
liquidations and downward pressure on prices.'' The study discusses 
the interconnectedness between financial institutions in general and 
does not focus on the potential role of BDs and IAs.
    \400\ See Billio M., M. Getmansky, A.W. Lo, and L. Pelizzon. 
2012. Econometric Measures of Connectedness and Systemic Risk in the 
Finance and Insurance Sectors, Journal of Financial Economics, 104, 
535-559. The study examines and finds evidence that banks, brokers, 
hedge funds and insurance companies have become highly interrelated 
during the last decade, thus increasing the level of systemic risk 
in the financial sector. For example, insurance companies have had 
little to do with hedge funds until recently when these companies 
expanded into markets such as providing insurance for financial 
products and credit default swaps. Such activities have potential 
implications for systemic risk when conducted on a large scale.
---------------------------------------------------------------------------

2. Senior Executive Officers and Significant Risk-Takers
    The requirements under the proposed rule would place differential 
restrictions on compensation arrangements of covered persons. Within 
each covered institution, the proposed rule would create different 
categories of covered persons, which include any executive officer, 
employee, director, or principal shareholder that receives incentive-
based compensation. While the proposed rule would apply to directors or 
principal shareholders who receive incentive-based compensation, the 
SEC's baseline analysis suggests that most of the parent institutions 
provide incentive-based compensation to non-employee directors but none 
of them provide such compensation arrangements to principal 
shareholders that are neither executives nor non-employee directors. 
Below, the SEC focuses the discussion of the economic effects of the 
proposed rule on two types of covered persons: Senior executive 
officers and significant risk-takers.
    As discussed above, a senior executive officer is defined as a 
covered person who holds the title or, without regard to title, salary, 
or compensation, performs the function of one or more of the following 
positions at a covered institution for any period of time in the 
relevant performance period: President, executive chairman, CEO, CFO, 
COO, chief investment officer, chief legal officer, chief lending 
officer, chief risk officer, chief compliance officer, chief audit 
executive, chief credit officer, chief accounting officer, or head of a 
major business line or control function (as defined in the proposed 
rule). A significant risk-taker is defined as a covered person, other 
than a senior executive officer, who receives compensation of which at 
least one-third is incentive-based compensation and is: Either (1) 
placed among the highest 5 percent in annual base salary and incentive-
based compensation among all covered persons (excluding senior 
executive officers) of a Level 1 covered institution or of any covered 
institution affiliate, or (2) placed among the highest 2 percent in 
annual base salary and incentive-based compensation among all covered 
persons (excluding senior executive officers) of a covered Level 2 
covered institution or of any covered institution affiliate, or (3) may 
commit or expose 0.5 percent or more of the common equity tier 1 
capital, or in the case of a registered securities broker or dealer, 
0.5 percent or more of the tentative net capital, of the covered 
institution or of any affiliate of the covered institution

[[Page 37779]]

that is itself a covered institution, or (4) is designated as a 
significant risk-taker by the SEC or the covered institution.
    The proposed rule would impose differential requirements on 
compensation arrangements of senior executive officers and significant 
risk-takers conditional on the size of the covered institution. 
Regarding senior executive officers, at least 60 percent of a senior 
executive officer's incentive-based compensation would be required to 
be deferred at a Level 1 covered institution, whereas 50 percent would 
be the minimum deferral amount for a senior executive officer at a 
Level 2 covered institution. Regarding significant risk-takers, 50 
percent of a significant-risk-taker's incentive-based compensation at a 
Level 1 covered institution would be required to be deferred as 
compared to 40 percent for a significant risk-taker's incentive-based 
compensation at a Level 2 covered institution. Moreover, the minimum 
deferral period for all covered persons at Level 1 covered institutions 
would be four years for qualifying incentive-based compensation and two 
years for incentive-based compensation received under long-term 
incentive plans whereas the deferral period for covered persons at a 
Level 2 covered institution would be three years for qualifying 
incentive-based compensation and one year for compensation received 
under long-term incentive plans.
    In general, the proposed rule would impose relatively stricter 
requirements for compensation arrangements of individuals who are more 
likely to be in a position to execute or authorize actions with 
accompanying risks that may have a significant impact on the financial 
health of the covered institution or of any covered institution 
affiliate. Specifically, the proposed rule would require a higher 
percentage of incentive-based compensation to be deferred for senior 
executive officers compared to significant risk-takers at covered 
institutions. If senior executive officers are in a position to make 
decisions that have a more significant impact on the degree of risk a 
covered institution takes than significant risk-takers, then the higher 
percentages of deferral amounts for senior executive officers appear to 
be commensurate with the degree of inappropriate risk-taking in which 
they could engage. This would likely provide proportionately stronger 
disincentives for inappropriate risk-taking by individuals that are 
more likely to be able to expose the covered institution to greater 
amounts of risk, thus potentially benefiting taxpayers and other 
stakeholders. In general, if certain significant risk-takers (e.g., 
traders with the ability to place significant bets that could endanger 
the financial health of the covered institution or of any affiliate of 
the covered institution) could engage in more or similarly significant 
risk-taking than senior executive officers, the proposed rules would 
place less stringent requirements on the compensation arrangements of 
such significant risk-takers compared to senior executive officers, 
lowering risk-taking disincentives for significant risk-takers and/or 
imposing a potential higher cost to senior executive officers. However, 
the proposed rules may also create an incentive for senior executive 
officers to monitor significant risk-takers in those situations when 
they do not directly supervise such significant risk-takers.
    While the definition of senior executive officer would be primarily 
based on job function, the definition of significant risk-taker would 
be based on multiple criteria. To identify significant risk-takers, one 
direct approach would require knowledge of their authority to expose 
their institution to material amounts of risk. This risk-based approach 
has intuitive appeal because it relates the application of the rules to 
the potential for risk taking. Such an approach could, however, be 
designed in many different ways, including differences relating to 
determining the appropriate risk-based measure, whether it should be 
applied to individuals or a group (e.g., a trader or a trading desk), 
and whether it would be appropriate to subject all trading activity to 
the same risk-based measure (e.g., U.S. treasury securities versus 
collateralized mortgage obligations). One of the criteria in the 
definition of significant risk-takers in the proposed rules is based on 
individuals' relative size of annual base salary and incentive-based 
compensation within a covered institution and its affiliates. If the 
highest paid individuals at BDs and IAs are the ones that could place 
BDs and IAs, or their parent institutions, at risk of insolvency, then 
the use of this criterion is likely to reasonably identify individuals 
that are significant risk-takers and as a result lower the likelihood 
of inappropriate risks being undertaken and potentially safeguard the 
health of these institutions and the broader economy. If, however, the 
highest paid individuals at BDs and IAs are not likely to be able to 
expose their parent institution to significant risks, this criterion 
may be overly inclusive, resulting in individuals being designated as 
significant risk-takers without possessing the ability to inflict 
substantial losses on BDs or IAs, or their parent institutions. This 
may impose restrictions on the compensation of those individuals and as 
a consequence may put BDs and IAs at a disadvantage in hiring or 
retaining human capital. BDs and IAs may have to increase the 
compensation of affected individuals to offset the restrictions imposed 
by the proposed rule.
    For IAs that are covered institutions in another capacity and BDs, 
the proposed rules would also identify significant risk-takers using a 
measure of their ability to expose the covered institution to risks. 
More specifically, a person that receives compensation of which at 
least one-third is incentive-based compensation and may commit or 
expose 0.5 percent or more of the common equity tier 1 capital, or in 
the case of a registered securities broker or dealer, 0.5 percent or 
more of the tentative net capital, of the covered institution or of any 
affiliate of the covered institution would be a significant risk-taker. 
As discussed above, the Agencies are proposing the exposure test 
because individuals who have the authority to expose covered 
institutions to significant amounts of risk can cause material 
financial losses to covered institutions. For example, in proposing the 
exposure test, the Agencies were cognizant of the significant losses 
caused by actions of individuals, or a trading group, at some of the 
largest financial institutions during and after the financial crisis 
that began in 2007. In the case of a covered institution that is a 
subsidiary of another covered institution and is smaller than its 
parent, this particular criterion of the significant risk-taker 
definition could result in individuals being classified as significant 
risk-takers who do not have the ability to expose significant amounts 
of the parent's capital to risk.
    Additionally, under the proposed definition of significant risk-
taker, a covered person of a BD or IA subsidiary of a parent 
institution that is a Level 1 or Level 2 covered institution may be 
designated as a significant risk-taker relative to: (i) In the case of 
a BD subsidiary, the size of the BD's tentative net capital or; (ii) in 
the case of both BD and IA subsidiaries, the tentative net capital or 
common equity tier 1 capital of any section 956 affiliate of the BD or 
IA, if the covered person has the ability to commit capital of the 
affiliate, even if the BD or IA subsidiary has significantly fewer 
assets than its parent. Because the BD subsidiary would be treated as a 
Level 1 or Level 2 covered institution due to its parent, a covered 
person of a BD that is a

[[Page 37780]]

relatively smaller subsidiary would be subject to more stringent 
compensation restrictions than would an employee of a comparably sized 
BD that is not a subsidiary of a Level 1 or Level 2 covered 
institution. As a consequence, if such a designated significant risk-
taker of a smaller BD subsidiary of a Level 1 or Level 2 covered 
institution is not in a position to undertake actions that place the 
entire institution at risk, then the proposed approach may impose 
disproportionately stricter compensation restrictions on such covered 
person.
    An alternative would be to use an individual's level of 
compensation as a proxy for his or her ability or authority to 
undertake risks within a corporate structure. The main assumption under 
this approach would be that there is a positive link between an 
individual's total compensation and that individual's authority to 
commit significant amounts of capital at risk at the covered 
institution or any affiliate of the covered institution. A benefit of 
the total compensation-based approach would be the implementation 
simplicity in the identification of significant risk-takers. However, 
the main challenge would be the determination of the total compensation 
threshold that would appropriately qualify individuals as significant 
risk-takers. On one hand, setting the total compensation threshold too 
low could impose incentive-based compensation restrictions on 
individuals that do not have authority to undertake significant risks. 
As a result, it is possible that incentive-based compensation 
requirements imposed on individuals that do not have significant risk-
taking authority could lead to a disadvantage in the efforts of the 
institutions to attract and retain talent. On the other hand, setting 
the total compensation threshold too high could impose incentive-based 
compensation restrictions on an incomplete set of significant risk-
takers, limiting the potential benefits of the proposed rule.
3. Consolidation of Subsidiaries
    The proposed rule would subject covered institution subsidiaries of 
a depository institution holding company that is a Level 1 or Level 2 
covered institution to the same requirements as the depository 
institution holding company. In this manner, the proposed rule would 
capture the effect that risk-taking within the subsidiaries of a 
depository institution holding company could have on the parent, and 
the negative externalities that could result for taxpayers.
    For example, covered persons at a $10 billion BD subsidiary of a 
depository institution holding company that is a Level 1 covered 
institution would be treated as covered persons of a Level 1 covered 
institution and subject to the proposed requirements and prohibitions 
applicable to covered persons at a Level 1 covered institution. One 
benefit of the proposed approach is the implementation simplicity of 
the proposed rule since the parent institution's size would determine 
the requirements for all covered persons in the covered institution's 
corporate structure. Such an approach also has the advantage that it 
may cover situations where the subsidiary could potentially expose the 
consolidated institution to substantial risks. This could be the case 
if for example the parent institution has provided capital to the 
subsidiary and the subsidiary is large enough that its failure would 
represent a significant loss for the parent institution. Moreover, such 
an approach curbs the possibility that a covered institution might 
place significant risk-takers in a smaller unregulated subsidiary, in 
order to evade the compensation restrictions of the proposed rule for 
individuals with authority to expose the institution to significant 
amounts of risk.
    There may also be costs associated with the proposed consolidation 
approach. The main disadvantage of such approach is that it may impose 
requirements and prohibitions on individuals employed in smaller 
subsidiaries that are less likely to be in a position to expose the 
institution to significant risks. Thus, the assumptions underlying the 
rule's consolidation may not be accurate in all cases. The proposed 
rules' treatment of subsidiaries would depend on their size and the 
size of their parent, and also on the effect that risk-taking within 
those subsidiaries could have on the potential failure of the parent 
institution and the potential risk that such a failure could impose on 
the overall financial system and the subsequent negative externality 
that this could create for taxpayers. For example, if the parent 
institution does not explicitly provide capital or implicitly guarantee 
the subsidiary's positions, the proposed rules would impose similar 
requirements on the incentive-based compensation of individuals with 
different abilities to expose the institution to risk. Such 
compensation requirements may impose costs on individuals in these 
subsidiaries, and it might affect the ability of these subsidiaries to 
compete for managerial talent with stand-alone companies of the same 
size as the subsidiary. If that were the case, the subsidiaries of 
larger parent institutions may have to provide additional pay to 
individuals to compensate for the relatively stricter compensation 
requirements and prohibitions. If these additional compensation 
requirements are significantly costly, there may be incentives for 
smaller subsidiaries to spin-off from their parents and operate as 
stand-alone firms to avoid the stricter compensation requirements that 
would be applicable based on the size of the parent institution.
    Additionally, the costs of the proposed consolidation approach 
would depend on how different the current incentive-based compensation 
arrangements of a subsidiary are from those of its parent institution. 
If the compensation arrangements of BDs' and IAs' covered persons are 
similar to those of their parent institutions (e.g., they use similar 
deferral percentages and terms, prohibit hedging, etc.), then the 
proposed consolidation approach is not likely to lead to significant 
compliance costs for BDs and IAs. The 2010 Federal Banking Agency 
Guidance has significantly limited differences in compensation 
arrangements between financial institutions and their subsidiaries. If, 
however, the compensation arrangements at BDs and IAs more closely 
resemble the compensation structures of financial institutions of 
similar size, than the proposed rule's consolidation requirement may 
lead to significant compliance costs. Unconsolidated Level 3 BDs and 
IAs are most likely to be affected by this proposition. The parent 
institutions of Level 3 BDs, to the extent that they are owned by one, 
are mainly Level 1 and Level 2 covered institutions. Although the SEC 
does not have data about the parent institutions of Level 3 IAs, the 
SEC expects that they would also be mainly Level 1 and Level 2 covered 
institutions. As shown above, compensation practices at Level 3 parent 
institutions differ significantly from Level 1 and Level 2 parent 
institutions on a number of dimensions: They defer a smaller fraction 
of NEOs incentive-based compensation (Table 7A), defer cash less 
frequently (Table 7A), and tend to use more options as part of their 
incentive-based compensation (Table 6A) compared to Level 1 and Level 2 
parent institutions. They also rather infrequently prohibit hedging 
with respect to non-employee directors that receive incentive-based 
compensation (Table 10A). If the compensation arrangements of 
unconsolidated Level 3 BDs and IAs are similar to those of Level 3 
parent institutions, under the proposed rule they would need to make 
significant

[[Page 37781]]

changes to certain features of their compensation arrangements to be 
compliant with the proposed rule. On the other hand, to the extent that 
their current compensation practices are not optimal from the 
perspective of taxpayers and other stakeholders of such BDs and IAs, 
there may be potential benefits. This point holds for the remainder of 
the economic analysis where the SEC discusses the potential costs and 
benefits to unconsolidated Level 3 BDs and IAs of a larger covered 
institution from applying the proposed rule requirements and 
prohibitions.
    An alternative to the proposed consolidation approach would be to 
use the subsidiary's size to determine its status as a Level 1, Level 
2, or Level 3 covered institution. For example, a $10 billion BD 
subsidiary of a Level 1 depository institution holding company would be 
treated as a Level 3 covered institution and covered persons within the 
subsidiary would be subject to all requirements and prohibitions 
applicable to a Level 3 covered institution. This alternative approach 
would not entail the potential costs identified in the proposed 
approach described above. However, differential application of the rule 
depending on subsidiary size could provide covered institutions with an 
incentive to re-organize their operations by placing significant risk-
takers into relatively smaller subsidiaries to bypass the proposed 
requirements. This type of behavior, however, might be mitigated in 
some circumstances by the proposed rule's prohibition on such indirect 
actions: A covered institution must not indirectly, or through or by 
any other person, do anything that would be unlawful for such covered 
institution to do directly under this part. Moreover, this type of 
behavior would be constrained by the fact that the SEC's capital 
requirements for broker-dealers require that the broker-dealer itself 
carry the necessary capital for all broker-dealer positions.\401\ 
Additionally, the rule's definition of a significant risk-taker would 
treat any employee of the subsidiary with the ability to commit certain 
amount of capital or to create risks for the parent institution as a 
significant risk-taker of the parent, further limiting the ability of 
institutions to bypass the proposed requirements by placing such 
individuals into relatively smaller subsidiaries.
---------------------------------------------------------------------------

    \401\ See 17 CFR 15c3-1(a).
---------------------------------------------------------------------------

E. Potential Costs and Benefits of the Proposed Rule's Requirements and 
Prohibitions
    In the following sections, the SEC provides an analysis of the 
potential costs and benefits associated with the proposed rule's 
requirements and prohibitions and possible alternatives.\402\ For 
purposes of this analysis, the SEC addresses the potential economic 
effects for covered BDs and IAs resulting from the statutory mandate 
and from the SEC's exercise of discretion together, recognizing that it 
is often difficult to separate the costs and benefits arising from 
these two sources. The SEC also requests comment on any economic effect 
the proposed requirements may have on covered BDs and IAs. The SEC 
appreciates comments that include both qualitative information and data 
quantifying the costs and the benefits identified in the analysis or 
alternative implementations of the proposed rule.
---------------------------------------------------------------------------

    \402\ Commenters on the 2011 Proposed Rule suggested more 
expansive discussion and analysis of economic effects of the 
proposed rulemaking on items such as the ability of covered 
institutions to compete for talent acquisition and retention (See, 
for example, letters by the U.S. Chamber and FSR), and also on the 
effects of the rule on risk taking incentives and its consequences 
for covered institutions' ability to compete (See, for example, 
FSR). Below, the SEC's economic analysis outlines and discusses 
potential economic effects of the various rule provisions, including 
items identified in comment letters discussing economic 
considerations.
---------------------------------------------------------------------------

1. Limitations on Excessive Compensation
    The proposed rule would prohibit covered institutions from 
establishing or maintaining any type of incentive-based compensation 
arrangement, or any feature of any such arrangement, that encourages 
inappropriate risk-taking by providing a covered person with excessive 
compensation, fees, or benefits or that could lead to material loss for 
the institution.
    The proposed rule would not define excessive compensation; instead, 
it would use a principles-based approach that would provide covered 
institutions with the flexibility to structure incentive-based 
compensation arrangements that do not constitute excessive compensation 
based on several factors that are outlined below. These factors would 
include: The total size of a covered person's compensation; the 
compensation history of the covered person and other individuals with 
comparable expertise at the institution; the financial condition of the 
covered institution; compensation practices at comparable institutions 
based upon such factors as asset size, geographic location, and the 
complexity of the covered institution's operations and assets; for 
post-employment benefits, the projected total cost and benefit to the 
covered institution; and any connection between the covered person and 
any fraudulent act or omission, breach of trust or fiduciary duty, or 
insider abuse with regard to the covered institution.
    The flexibility that the proposed rule provides would likely 
benefit covered institutions by allowing them to tailor the incentive-
based compensation arrangements to the skills and job requirements of 
each covered person and to the nature of a particular institution's 
business and the risks thereof instead of applying a ``one size fits 
all'' approach. The differences in the size, complexity, 
interconnectedness, and degree of competition in the market for 
managerial talent among the institutions covered by the proposed rule 
make excessive compensation difficult to define universally.
    As mentioned above, a principles-based approach is likely to 
provide greater discretion to covered institutions in tailoring 
compensation arrangements that do not provide incentives for 
inappropriate risk-taking. Such discretion may potentially allow for 
differential interpretation among covered institutions on what 
constitutes excessive compensation and as a consequence, differential 
compensation arrangements even for similar institutions could be 
designed. Given the flexibility inherent under a principles-based 
approach, it is also possible that in fact some compensation contracts 
to covered persons constitute excessive compensation that could lead to 
inappropriate risk-taking, particularly if the compensation setting 
process is not efficient or unbiased.\403\ It is also possible that 
boards of directors may find it difficult to evaluate whether a 
compensation arrangement creates excessive compensation that could lead 
to inappropriate risk-taking. As such, it is likely that governance 
mechanisms in place would be crucial for institutions to benefit from 
the flexibility of the principles-based approach and avoid the 
potential costs described above.
---------------------------------------------------------------------------

    \403\ For example, see Coles, J., Daniel, N., and Naveen, L. Co-
opted Boards. 2014. Review of Financial Studies 27, 1751-1796.
---------------------------------------------------------------------------

    An alternative would be a more prescriptive approach in defining 
compensation arrangements that constitute excessive compensation. For 
example, an explicit definition of excessive compensation could be 
provided for covered institutions. As mentioned above, such an approach 
has

[[Page 37782]]

the disadvantage of restricting compensation arrangement options for 
covered institutions and thus an increased likelihood that inefficient 
compensation arrangements would be applied to at least some covered 
institutions, given the significant differences among covered 
institutions and covered persons.
2. Performance Measures
    The proposed rule would require covered institutions to use a 
variety of performance measures when determining the incentive-based 
compensation of covered persons. Incentive-based compensation 
arrangements would be required to include a mix of financial (i.e., 
accounting and stock-based) measures and non-financial measures, with 
the ability for non-financial measures to override financial measures 
when appropriate. Additionally, any amounts to be awarded under the 
arrangement would be subject to adjustment to reflect actual losses, 
inappropriate risks taken, compliance deficiencies, or other measures 
or aspects of financial and non-financial performance.
    There is evidence in the economic literature suggesting that non-
financial measures of performance are incremental predictors of long-
term financial performance relative to financial measures of 
performance, and provide important information about executives' 
performance.\404\ Moreover, non-financial measures of performance in 
compensation arrangements may better capture progress or milestones of 
strategic goals that may be unique to specific institutions.\405\ Thus, 
the proposed requirement to use a mix of the two types of measures 
would likely provide more relevant information to enable covered 
institutions to set up incentive compensation arrangements for covered 
persons. In addition, the flexibility that the proposed rule would 
provide to covered institutions to adjust the compensation awards based 
on various factors would allow covered institutions to tailor their 
compensation arrangements to their specific circumstances.
---------------------------------------------------------------------------

    \404\ See, e.g., Banker, R., G. Potter, and D. Srinivasan, 1999. 
An Empirical Investigation of an Incentive Plan that Includes 
Nonfinancial Performance Measures. The Accounting Review 75, 65-92. 
The study examines whether non-financial measures of performance, 
specifically customer satisfaction, are incremental predictors of 
future performance and whether inclusion of such measures of 
performance in compensation contracts is efficient. The study finds 
that customer satisfaction is incremental in predicting future 
financial performance and inclusion of such performance measure in 
compensation contracts leads to improved future performance.
    \405\ See, e.g., Ittner, C., D. Larcker, and T. Randall, 2003. 
Performance Implications of Strategic Performance Measurement in 
Financial Services Firms. Accounting, Organizations and Society 28, 
715-741. The study uses a sample of 140 U.S. financial services 
firms to examine the relation between measurement system 
satisfaction, economic performance, and two general approaches to 
strategic performance measurement: Greater measurement diversity and 
improved alignment with firm strategy and value drivers. The study 
finds evidence that firms making more extensive use of a broad set 
of financial and non-financial measures than firms with similar 
strategies or value drivers have higher measurement system 
satisfaction and stock market returns.
---------------------------------------------------------------------------

    The baseline analysis suggests that many of the public parent 
institutions of some BDs and IAs already use a mix of financial and 
non-financial measures in determining the incentive-based compensation 
awards of senior executive officers. To the extent that BDs and IAs use 
a similar mix of measures to determine the incentive-based compensation 
awards of their senior executive officers, the SEC expects the costs of 
compliance with this provision of the proposed rule to be relatively 
low. If BDs and IAs do not use the same mixture of financial and non-
financial measures as their parents, or do not rely on non-financial 
measures when determining the compensation of their senior executive 
officers and significant risk-takers, the compliance costs associated 
with this particular rule requirement may be significant. Such costs 
may be in the form of additional expenditures related to hiring 
compensation consultants and/or lawyers to design compensation schemes 
and assure the compliance of newly designed compensation schemes with 
the proposed rule.
    The SEC has attempted to quantify such costs using data reported by 
Level 1, Level 2, and Level 3 covered institutions that are parents of 
BDs and IAs. Table 14 provides some summary statistics on the use of 
compensation consultants and the fees paid to those over the period 
2007-2014.\406\ Based on the results in the table, Level 1 and Level 2 
covered institutions use on average two compensation consultants, while 
Level 3 covered institutions use one compensation consultant on 
average. If a Level 1 BD or IA has to hire compensation consultant(s) 
to help them meet this rule requirement, it may incur costs of 
approximately $185,515 per year. If an unconsolidated Level 2 BD or IA 
has to hire compensation consultant(s) to help them meet this rule 
requirement, it may incur costs of approximately $77,000 per year.\407\ 
If an unconsolidated Level 3 BD or IA, because of the consolidation 
requirement, has to hire compensation consultant(s) to help meet this 
rule requirement, it may incur costs of approximately $18,788 per year. 
These costs could be higher if the compensation consultant is asked to 
provide additional services other than compensation consulting 
services. These costs could be lower, however, if the parent 
institutions of BDs and IAs already employ compensation consultants and 
could extend their services to meet the proposed rule requirements for 
BDs and IAs.
---------------------------------------------------------------------------

    \406\ Data used in the table comes from the ISS database.
    \407\ We note that while we report the median consulting fee for 
covered institutions in Table 14, the average compensation 
consultant fees are higher. For example, for Level 1 covered 
institutions the average consulting fee is $198,673, for Level 2 
covered institutions the average consulting fee is $293,501, and for 
Level 3 covered institutions the average consulting fee is $59,828. 
The presence of outliers in the compensation consulting fee data and 
the small sample size are the reason for the large difference 
between average and median consulting fee.

    Table 14--The Use and Costs of Compensation Consultants by Certain Level 1, Level 2, and Level 3 Covered
                             Institutions That Are Parents of BDs and IAs, 2007-2014
----------------------------------------------------------------------------------------------------------------
                                                                                    Median fees
                                                                      Average     for consulting
                                                                     number of      services to      Number of
                                                                   compensation         the        institutions
                                                                    consultants    compensation
                                                                       used          committee
----------------------------------------------------------------------------------------------------------------
Level 1.........................................................               2         185,515               7
Level 2.........................................................               2          77,000               9
Level 3.........................................................               1          18,788               6
----------------------------------------------------------------------------------------------------------------


[[Page 37783]]

3. Board of Directors
    Additionally, the proposed rule would require that the board of 
directors of covered institutions oversee a covered institution's 
incentive-based compensation program, and approve incentive-based 
compensation arrangements for senior executive officers or any material 
exceptions or adjustments to incentive-based compensation policies or 
arrangements.
    Since overseeing and approving executive compensation arrangements 
is one of the primary functions of the compensation committee of the 
corporate board, the SEC believes that this rule requirement would not 
impose significant compliance costs on covered institutions that 
already have compensation committees. Moreover, because the baseline 
analysis suggests that the majority of the parents of some covered 
institutions already employ most of the requirements and limitations of 
the proposed rule, it may not be particularly costly for boards of 
directors or compensation committees to comply with the proposed rule. 
However, there might be additional compliance costs for covered 
institutions if the board of directors or the compensation committee 
have to exert incremental effort (i.e., meet more frequently) in 
designing and approving compensation arrangements. Additionally, if 
because of the rule's definition of significant risk-takers the 
compensation committee of a covered institution has to cover a much 
larger number of employees and consider additional factors than it does 
at present, this may increase compliance costs.
    For covered BDs and IAs that do not have compensation committees, 
the board of directors as a whole may be able to oversee and approve 
executive compensation arrangements. Thus, for such BDs and IAs the 
compliance costs of this rule requirement could result in more time 
being spent for the board of directors on these issues, which might 
entail higher directors' fees and possibly additional compensation 
consulting costs.
4. Disclosure and Recordkeeping
    The proposed rule would require all covered institutions to create 
annually and maintain for a period of at least 7 years records that 
document the structure of all its incentive-based compensation 
arrangements and demonstrate compliance with the proposed rule. At a 
minimum, these must include copies of all incentive-based compensation 
plans, a record of who is subject to each plan, and a description of 
how the incentive-based compensation program is compatible with 
effective risk management and controls.
    The SEC is proposing an amendment to Exchange Act Rule 17a-4(e) 
\408\ and Investment Advisers Act Rule 204-2 \409\ to require that 
registered broker-dealers maintain and investment advisers, 
respectively, the records required by the proposed rule, in accordance 
with the recordkeeping requirements of Exchange Act Rule 17a-4 and 
Investment Advisers Act Rule 204-2, respectively. Exchange Rule 17a-4 
and Investment Advisers Act Rule 204-2 establish the general formatting 
and storage requirements for records that registered broker-dealers and 
investment advisers, respectively, are required to keep. For the sake 
of consistency with other broker-dealer and investment adviser records, 
the SEC believes that registered broker-dealers and investment 
advisers, respectively, should also keep the records required by the 
proposed rule, in accordance with these requirements.
---------------------------------------------------------------------------

    \408\ 17 CFR 240.17a-4(e).
    \409\ 17 CFR 275.204-2.
---------------------------------------------------------------------------

    The proposed recordkeeping requirement would assist covered BDs and 
IAs in monitoring incentive-based compensation awards and payments and 
comparing them with actual risk outcomes to determine whether 
incentive-based compensation payments to senior executive officers and 
significant risk-takers lead to inappropriate risk-taking. The proposed 
recordkeeping requirement would also help BDs and IAs to modify the 
incentive-based compensation arrangements of senior executive officers 
and significant risk-takers, if, over time, incentive-based 
compensation paid does not appropriately reflect risk outcomes. These 
records would be available to SEC staff for examination, which may 
enhance compliance and facilitate oversight.
    This proposed requirement would likely impose compliance costs on 
covered institutions. The SEC expects the magnitude of the compliance 
costs to depend on whether broker-dealers and investment advisers 
already have a system in place to generate information regarding their 
compensation practices for internal use (e.g., for reports to the board 
of directors or the compensation committee) or for required disclosures 
under the Exchange Act (for reporting companies). To the extent that 
such existing platforms can be expanded to produce the records required 
under the proposed rule, the SEC expects this requirement to impose 
lower compliance costs on these institutions. The compliance costs 
associated with this particular proposed rule requirement would likely 
be higher for covered institutions that may not be generating such 
information, if for example they are not subject to related reporting 
obligations, or may not keep the type and detail of records that would 
be required under the proposed rule. Given that all Level 1 and 
unconsolidated Level 2 BDs, and most unconsolidated Level 3 BDs and 
IAs, are non-reporting companies, the SEC expects that the 
recordkeeping costs associated with the rule may be substantial for 
these BDs and IAs. The SEC notes, however, that because it does not 
have information on the compensation reporting and recordkeeping at the 
subsidiary level, the SEC may be overestimating compliance costs for 
BDs and IAs with reporting parent institutions. For example, if the 
parent institution reports and keeps records of the incentive-based 
compensation arrangements at the subsidiary level, and on the same 
scale and detail as required by the proposed rule, it is possible that 
the compliance costs for such BDs could be lower than the compliance 
costs for BDs with non-reporting parent institutions. Since the SEC 
does not have data on how many covered IAs have parent institutions, it 
is also possible that a significant number of these IAs may be stand-
alone companies and therefore could have higher costs to comply with 
the proposed rule compared to covered IAs and BDs that are part of 
reporting parent institutions.
    According to the 2010 Federal Banking Agency Guidance, a banking 
organization should provide an appropriate amount of information 
concerning its incentive compensation arrangements for executive and 
non-executive employees and related risk-management, control, and 
governance processes to shareholders to allow them to monitor and, 
where appropriate, take actions to restrain the potential for such 
arrangements and processes to encourage employees to take imprudent 
risks. Such disclosures should include information relevant to 
employees other than senior executive officers. The scope and level of 
the information disclosed by the institution should be tailored to the 
nature and complexity of the institution and its incentive compensation 
arrangements. Thus, private covered institutions that are banking 
institutions and apply the policies of the 2010 Federal Banking Agency 
Guidance may already be

[[Page 37784]]

collecting the information that would be required by the proposed rule. 
The SEC expects the compliance costs to be lower for such covered 
institutions, to the extent that there is an overlap between the 
information collected under the 2010 Federal Banking Agency Guidance 
and the information that would be required for disclosure and 
recordkeeping under the proposed rule. The BDs and IAs that are stand-
alone non-reporting firms or have non-reporting parent institutions 
that are not banking institutions would most likely be the ones to 
incur higher compliance costs of disclosure and recordkeeping.
    By requiring covered institutions to create and maintain records of 
incentive-based compensation arrangements for covered persons at all 
covered BDs and IAs, the proposed recordkeeping requirement is expected 
to facilitate the SEC's ability to monitor incentive-based compensation 
arrangements and could potentially strengthen incentives for covered 
institutions to comply with the proposed rule. As a consequence, an 
increase in investor confidence that covered institutions are less 
likely to be incentivizing inappropriate actions through compensation 
arrangements may occur and potentially result in greater market 
participation and allocative efficiency, thereby potentially 
facilitating capital formation. As discussed above, it is difficult for 
the SEC to estimate compliance costs related to the specific provision. 
However, for covered institutions that do not currently have a similar 
reporting system in place, there could be significant fixed costs that 
may disproportionately burden smaller covered BDs and IAs and hinder 
competition. Overall, the SEC does not expect the effects of the 
proposed recordkeeping requirements on efficiency, competition and 
capital formation to be significant.
5. Reservation of Authority
    Under the proposed rule, an Agency may require a Level 3 covered 
institution with average total consolidated assets greater than or 
equal to $10 billion and less than $50 billion to comply with some or 
all of the provisions of Sec. Sec.  5 and 7 through 11of the proposed 
rule applicable to Level 1 and Level 2 covered institutions if the 
agency determines that such Level 3 covered institution's complexity of 
operations or compensation practices are consistent with those of a 
Level 1 or Level 2 covered institution.
    This proposed rule requirement would allow the SEC to treat senior 
executive officers and significant risk-takers at BDs and IAs that have 
total consolidated assets below $50 billion as covered persons of a 
Level 1 or Level 2 covered institution, because, for example, the 
complexity of the BDs' and IAs' operations or risk profile could have a 
significant impact on the overall financial system and could generate 
negative spillover effects for taxpayers. As a result, the number of 
BDs and IAs that would be subject to the portions of the proposed rule 
applicable to Level 1 and Level 2 covered institutions may increase 
relative to the estimates presented in the baseline.\410\
---------------------------------------------------------------------------

    \410\ As discussed above in the Baseline section, as of the end 
of 2014, there were 33 BDs with total consolidated assets between 
$10 and $50 billion. Due to the lack of data, the SEC cannot 
determine the number of IAs with total consolidated assets between 
$10 and $50 billion.
---------------------------------------------------------------------------

    The proposed requirement may increase compliance costs for these 
BDs and IAs. As shown above, Level 3 parent institutions differ 
significantly from Level 1 and Level 2 parent institutions on a number 
of dimensions: They tend to defer a smaller fraction of NEOs incentive-
based compensation (Table 7A), tend to defer cash less frequently 
(Table 7A), and tend to use more options as part of their incentive-
based compensation (Table 6A) compared to Level 1 and Level 2 parent 
institutions. They also use rather infrequently the prohibition of 
hedging with respect to non-employee directors that receive incentive-
based compensation (Table 9A). If the compensation arrangements of 
Level 3 BDs and IAs are similar to those of Level 3 parent 
institutions, then for Level 3 BDs and IAs that are designated as Level 
1 or Level 2 covered BDs and IAs by an Agency, the proposed rule is 
likely to require significant changes to certain features of their 
compensation arrangements to be in compliance.
F. Potential Costs and Benefits of Additional Requirements and 
Prohibitions for Level 1 and 2 Covered Institutions
1. Mandatory Deferral
    The proposed rule would require a minimum amount of annual 
incentive-based compensation to be deferred for a minimum number of 
years for senior executive officers and significant risk-takers at 
Level 1 and Level 2 covered institutions. For senior executive officers 
and significant risk-takers at Level 1 and Level 2 BDs and IAs, such 
requirement is expected to establish a minimum accountability horizon 
with respect to the outcomes of actions of these individuals, including 
the realization of longer-term risks that may be associated with such 
actions.
    As discussed above, from an economic standpoint, managerial actions 
carry associated risks, and the horizon over which such risks unfold is 
uncertain. If the risk realization horizon is longer than the 
performance period used to measure and compensate the performance of 
senior executive officers and significant risk-takers, they may have an 
incentive to undertake projects that deliver strong short-term 
performance at the potential expense of long-term value. A minimum 
compensation deferral period aims to curb incentives for such undesired 
behavior by increasing senior executive officers' and significant risk-
takers' accountability for the potential adverse outcomes of their 
actions that may be realized in the long run, which in turn may 
discourage short-termism and inappropriate risk-taking and as a 
consequence lower the likelihood of default for the covered institution 
and the potential risk such a default could pose to the greater 
financial system.
    As discussed above, the proposed minimum deferral periods required 
by the proposed rule for Level 1 and Level 2 BDs and IAs covered 
institutions would relate to the horizons over which the risks in these 
institutions may be realized. The deferral periods are likely to 
overlap with a traditional business cycle to identify outcomes 
associated with a senior executive officer's or significant risk-
taker's performance and risk-taking activities. As noted, the business 
cycle reflects periods of economic expansion or recession, which 
typically underpin the performance of the financial sector. There might 
be specific facts and circumstances (for example, the variety of assets 
held, the changing nature of those assets over time, the normal 
turnover in assets held by financial institutions, and the complexity 
of the business models of BDs and IAs) that may affect the horizon over 
which risks may be realized for particular covered institutions, so a 
uniform deferral period may be more or less aligned with the horizon 
over which a particular covered institution realizes certain risks.
    With regard to the type of incentive-based compensation instruments 
to be deferred, the rule proposes to require deferred compensation to 
consist of substantial amounts of both cash and equity-linked 
instruments. Whereas deferred equity-linked compensation would be 
subject to both upside potential (for example, if the stock price of 
the firm increases during the deferral period) and downside risk, the 
cash component of deferred compensation

[[Page 37785]]

would be mainly subject to downside risk, thus resembling the payoff 
structure of a debt security. More specifically, the cash component of 
deferred compensation would not appreciate in value if firm performance 
during the deferral period is positive, but would be subject to 
downward adjustment, forfeiture, and clawback if, for example, the 
executive has engaged in inappropriate risk-taking that results in poor 
performance during the performance, deferral and post-deferral periods 
respectively. This asymmetry in the payoff structure of the cash 
component of deferred compensation is expected to provide incentives 
for responsible risk-taking by covered persons thus lowering the 
likelihood of default at these institutions as well as the 
corresponding risk to the greater financial system posed by certain 
large, complex, and interconnected institutions.\411\ Economic studies 
suggest a negative relation between pre-crisis levels of managerial 
debt holdings and measures of default risk during the crisis for bank 
holding companies--bank holding companies whose executives held larger 
debt holdings were less likely to default.\412\
---------------------------------------------------------------------------

    \411\ The academic literature provides evidence regarding the 
effect of compensation instruments resembling a debtholder's payoff 
and the effect of such compensation instruments on various aspects 
of the agency costs of debt. For example, there is evidence of a 
negative relation between levels of inside debt and the cost of 
debt; see Anantharaman et al. 2013. Inside debt and the design of 
corporate debt contracts. Management Science 60, 1260-1280. Also, 
studies have documented a negative relation between inside debt and 
restrictiveness of debt covenants and demand for accounting 
conservatism, and a positive relation between CEO inside debt and 
firm liquidation values; see Chen, F., Y. Dou, and X. Wang. 2010. 
Executive Inside Debt Holdings and Creditors' Demand for Pricing and 
Non-Pricing Protections. Working Paper. With respect to the 
mechanism through which inside debt holdings lead to lower firm 
risk, evidence suggests that such firms apply more conservative 
investment as well as financing choices. Inside debt in particular 
has been shown to be negatively related to future stock return 
volatility, a market-based measure of risk; see Cassell, Cory A., 
Shawn X. Huang, Juan Manuel Sanchez, and Michael D. Stuart. 2012. 
The relation between CEO inside debt holdings and the riskiness of 
firm investment and financial policies. Journal of Financial 
Economics 103, 588-610.
    It must be noted that the academic literature proxies for such 
debt-like compensation instruments mostly through pensions and other 
forms of deferred compensation. Such instruments may not fully 
resemble the characteristics of deferred cash under the rule, 
particularly with respect to the horizon of deferral as well as the 
vesting schedules (pro-rata vs. cliff-vesting).
    \412\ See Bennett et al. (2015). Inside Debt, Bank Default Risk, 
and Performance during the Crisis. Journal of Financial 
Intermdiation 24, 487-513. The study examines the relation between 
pre-crisis levels of inside equity vs. inside debt holdings by bank 
holding company CEOs and risk and performance of these BHCs during 
the crisis. The findings reveal a negative relation between pre-
crisis CEO inside debt holdings and default risk during the crisis, 
and higher supervisory ratings for these BHCs before the crisis.
---------------------------------------------------------------------------

    As mentioned above, the deferral requirements of the proposed rule 
for senior executive officers and significant risk-takers at the 
largest covered institutions are also consistent with international 
standards on compensation. Having standards that are generally 
consistent across jurisdictions would ensure that covered institutions 
in the United States, compared to their non-U.S. peers, are on a level 
playing field in the global competition for talent.
    The mandatory deferral requirements of the proposed rule may impose 
significant costs on affected BDs and IAs.\413\ As a consequence of the 
mandatory deferral requirement, the wealth of covered persons would be 
likely less diversified and more tied to prolonged periods of a covered 
institution's performance. This potential deterioration of wealth 
diversification may induce covered persons to demand an increase in pay 
which could result in higher compensation-related costs for covered 
institutions.\414\ This increase in compensation costs may be necessary 
in order for covered institutions to be able to both attract and retain 
human talent. The SEC notes, however, that there may be other factors 
affecting the ability of a covered institution to attract and retain 
human talent, such as the supply of talent and non-pecuniary benefits 
of employment at covered institutions. These factors may exacerbate or 
mitigate the potential increase in compensation costs. For example, if 
senior executive officers and significant risk-takers value non-
pecuniary job benefits such as prestige, networking, and visibility, 
these benefits may offset the costs associated with deterioration in 
the diversification of their portfolios.
---------------------------------------------------------------------------

    \413\ Several commenters raised accounting related issues with 
respect to covered institutions' financial statements under the 
proposed rule (see, e.g., KPMG, CEC) and tax related issues with 
respect to individuals affected by the proposed rule (see, e.g., 
KPMG, MFA, SIFMA, CEC, PEGCC).
    \414\ Three commenters argued that the proposed rule could 
result in unintended consequences such as higher fixed compensation 
or other benefits (See FSR, WLF, U.S. Chamber).
---------------------------------------------------------------------------

    As a result of the proposed compensation deferral requirement, 
covered persons at BDs and IAs may be incentivized to curb 
inappropriate risk-taking given the increased accountability over their 
actions. There could be situations, however, where bonus deferral could 
actually lead to an increase in risk-taking incentives.\415\ For 
example, if firm performance during the deferral period significantly 
declines and causes a significant loss in the value of deferred 
compensation, senior executive officers and significant risk-takers 
could potentially have an incentive to engage in high-risk actions in 
an effort to recoup at least some of the value of their deferred 
compensation.
---------------------------------------------------------------------------

    \415\ See Leisen, D. (2014). Does Bonus Deferral Reduce Risk 
Taking? Working Paper. The paper develops a model comparing risk-
taking incentives from bonuses with and without deferral. The 
results challenge the common belief that bonus deferral 
unequivocally leads to reduced risk-taking incentives; under certain 
conditions, deferral of bonus could lead to stronger risk-taking 
incentives during the deferral period.
---------------------------------------------------------------------------

    As discussed above, deferral of the cash component of compensation 
resembles the payoff structure of debt and as a consequence may expose 
managerial compensation to risk without a corresponding upside. Whereas 
this may provide incentives to covered persons to avoid actions that 
would expose a covered institution to higher likelihood of default and 
for important institutions risks to the financial system, such 
incentives may result in misalignment of interests between managers and 
shareholders and potentially harm shareholder value. Several studies 
suggest that managers with significant debt instruments in their 
compensation arrangement tend to undertake a more conservative approach 
in managing their firms.\416\ The significant use of debt in 
compensation arrangements is viewed negatively by shareholders: Stock 
prices of companies whose executives hold significant debt positions 
experience a decrease upon disclosure of such compensation 
arrangements.\417\ Thus, whereas the utilization of debt-like 
instruments in compensation arrangements in important institutions may 
lower the risk to the greater financial system, this may come at the 
expense of shareholder value at these institutions. One commenter 
suggested that the proposed rule could cause covered institutions to 
perform in a less competitive way given lower incentives for risk-
taking.\418\
---------------------------------------------------------------------------

    \416\ See Anantharaman, D., V.W. Fang, and G. Gong. 2014. Inside 
Debt and the Design of Corporate Debt Contracts. Management Science 
60, 1260-1280; Chen et al. (2010); and Cassell et al. (2012).
    \417\ See Wei, C., and Yermack, D. (2011).
    \418\ See FSR.
---------------------------------------------------------------------------

    Alternatively, the Agencies could have proposed higher deferral 
percentages and/or longer deferral horizons. Some commenters \419\ 
suggested more stringent deferral requirements, such as a longer 
deferral

[[Page 37786]]

horizon,\420\ a higher percentage subject to deferral,\421\ and holding 
the entire deferred amount back until the end of the deferral 
period.\422\ For example, the Agencies could have selected a seven-year 
deferral for senior executive officers and a five-year horizon deferral 
horizon for significant risk-takers, similar to the rules that the 
Prudential Regulation Authority has recently proposed in the UK. Such 
long deferral periods may have allowed for longer-term risks to 
materialize and thus be accounted for when calculating managerial 
compensation. On the other hand, as mentioned above, longer deferral 
periods could result in inappropriate risk-taking if firm performance 
during the deferral period significantly declines and causes a 
significant loss in the value of deferred compensation. Additionally, a 
longer deferral period increases the probability that financial 
performance is impacted by actions or factors that are not related to 
covered persons' actions and as such result in an inefficient 
compensation contract. Moreover, lengthening of the deferral period is 
likely to lead to increased liquidity issues for covered persons since 
their compensation cannot be cashed out on a timely basis to meet their 
liquidity needs. Finally, it is also possible that further prolonging 
of the deferral period could create incentives for institutions to 
shift away from incentive-based compensation and increase the fixed 
component of compensation. A potential consequence from such action may 
be distortion of value-enhancing incentives that are generated through 
incentive-based compensation. Another potential cost from deferral 
requirements that are more strict could be that affected institutions 
may not be able to compete and as a consequence lose talent to other 
sectors that are not subject to the proposed rule.
---------------------------------------------------------------------------

    \419\ It should be noted that comments were based on the 2011 
Proposed Rule's 3-year deferral period (as opposed to the 4-year 
deferral period currently proposed).
    \420\ See AFR, Public Citizen, Chris Barnard, AFSCME, AFL-CIO, 
Senator Brown.
    \421\ See AFR, Public Citizen, AFSCME.
    \422\ See AFR, Senator Brown, Public Citizen.
---------------------------------------------------------------------------

    Another alternative could be shorter deferral periods (e.g., 
deferral period of less than four years for the qualifying incentive-
based compensation of senior executive officers at Level 1 covered 
institutions; for example, 3 years as in the 2011 Proposed Rule) and/or 
smaller deferral percentages (e.g., deferral of less than 60 percent of 
qualifying incentive-based compensation for senior executive officers 
at Level 1 covered institutions; for example, 50 percent as in the 2011 
Proposed Rule). A shorter deferral period and/or smaller deferral 
percentage amount, however, may not provide adequate incentives to 
covered persons to engage in responsible risk-taking. On the other 
hand, if the risk realization horizon is actually shorter than the 
deferral horizon proposed in the rule, then using a shorter deferral 
period would avoid exposing covered persons' wealth to risks that do 
not result from their actions and would also impose lower liquidity 
constraints on undiversified executives. From the baseline analysis of 
current compensation practices, it appears that all of the Level 1 
public parent institutions and most of the Level 2 public parent 
institutions of BDs and IAs already have deferral policies in place 
similar to the proposed rule requirements. Currently, about 50 percent 
to 75 percent of incentive-based compensation is deferred for a period 
of about three years, and the deferral includes NEOs, non-NEOs and 
significant risk-takers.
    If the compensation structure of BDs and IAs is similar to that of 
their parent institutions, and the compensation structure of private 
institutions is similar to that of public institutions, for the covered 
BDs and IAs the implementation of the deferred aspect of the proposed 
rule is unlikely to lead to significant compliance costs. The only 
potentially significant compliance costs that such covered institutions 
could incur with respect to the deferral requirement is related to the 
deferral of cash compensation, which currently only 20 percent to 25 
percent of Level 1 and Level 2 covered institutions defer, and the 
prohibition on accelerated vesting, which very few of the Level 2 
covered parent institutions currently use. On the other hand, if the 
compensation practices of parent institutions are significantly 
different than those at their subsidiaries, covered BDs and IAs could 
experience significant compliance costs when implementing the proposed 
deferral rule. Since the SEC does not have data on how many covered IAs 
have parent institutions, it is also possible that a significant number 
of these IAs may be stand-alone companies and therefore could have 
higher costs to comply with the proposed rule compared to covered IAs 
and BDs that are part of reporting parent institutions. As discussed 
above, the SEC has data regarding the incentive-based compensation 
arrangements at the depository institution holding company parents of 
Level 1 and unconsolidated Level 2 and unconsolidated Level 3 BDs and 
IAs because many of those bank holding companies are public reporting 
companies under the Exchange Act. The SEC lacks information regarding 
the compensation arrangements of BDs and IAs that are not so 
affiliated, and hence the SEC cannot accurately assess the compliance 
costs for those issuers. The same holds true if the incentive-based 
compensation practices at BDs and IAs are generally different than 
those at banking institutions, which most of their parent institutions 
are. Lastly, because some BDs and IAs are subsidiaries of private 
parent institutions, if there is a significant difference in the 
compensation practices between public and private covered institutions 
such private BDs and IAs could face larger compliance costs. To better 
assess the effects of deferral on compliance costs for BDs and IAs the 
SEC requests comments on these issues.
2. Options
    For senior executive officers and significant risk-takers at Level 
1 and Level 2 covered institutions, the proposed rule would limit the 
amount of stock option-based compensation that can qualify for 
mandatory deferral at 15 percent, effectively placing a cap on the use 
of stock options as part of the incentive-based compensation 
arrangements for senior executive officers and significant risk-takers 
at Level 1 and Level 2 covered institutions.\423\ This implies that 45 
percent of incentive-based compensation would have to be in some other 
form to fulfill the 60 percent deferral amount for a senior executive 
officer or significant risk-taker at a Level 1 and Level 2 covered 
institution. As discussed in the Broad Economic Considerations section, 
the payoff structure from stock options is asymmetric and thus 
generates incentives for executives to undertake risks. For the 
financial services industry in general, economic studies find that 
higher levels of stock options in compensation arrangements of publicly 
traded bank CEOs are positively related to multiple measures of risk, 
such as equity volatility.\424\ Thus, limiting the

[[Page 37787]]

use of stock options in compensation arrangements could result, on 
average, in lower risk-taking incentives for senior executive officers 
and significant risk-takers at Level 1 and Level 2 covered 
institutions. As previously noted, however, the link between stock 
options and risk-taking is not indisputable. For example, a study that 
examined the effect of a decrease in the provision of stock options in 
compensation arrangements due to an unfavorable change in accounting 
rules regarding option expensing, did not identify decreased risk-
taking by executives as a response to a decrease in stock options 
awards.\425\
---------------------------------------------------------------------------

    \423\ If stock options awarded are not part of incentive-based 
compensation, there is no limit to such awards.
    \424\ See Mehran, H., Rosenberg, J. 2009. The Effect of CEO 
Stock Options on Bank Investment Choice, Borrowing, and Capital. 
Federal Reserve Bank of New York. The study finds a positive 
relation between the use of stock options in bank CEO compensation 
arrangements and risk-taking as evident by higher levels of equity 
and asset volatility. The paper also finds that the increased risk 
exposure in these banks comes from riskier project choices rather 
than increased use of leverage.
    See DeYoung, R., Peng, E., Yan, M. 2013. Executive Compensation 
and Business Policy Choices at U.S. Commercial Banks. Journal of 
Financial and Quantitative Analysis 48, 165-196.
    See Chen, C., Steiner, T., Whyte, A. 2006. Does stock option-
based executive compensation induce risk-taking? An analysis of the 
banking industry. Journal of Banking and Finance 30, 915-945. The 
paper examines whether option-based compensation is related to 
various measures of risk for a sample of commercial banks. Option-
based compensation is positively related to various market measures 
of risk such as systematic and idiosyncratic risk. However, 
causality cannot be inferred; risk also has an effect on the 
structure of compensation arrangements.
    \425\ See Hayes, R., Lemmon, M., Qiu, M., 2012. `Stock options 
and managerial incentives for risk taking: Evidence from FAS 123R'. 
Journal of Financial Economics 105, 174-190. This study examines the 
effect of changes in option-based compensation, due to a change in 
the accounting treatment of stock options in 2005, on risk-taking 
behavior. Firms significantly reduce the use of stock options in 
compensation arrangements as a response to the unfavorable treatment 
of stock options in financial statements. However, the study finds 
little evidence that the decline in option usage resulted in less 
risky investment and financial policies.
---------------------------------------------------------------------------

    The unique characteristics of the financial services sector 
compared to the rest of the economy--significantly higher 
leverage,\426\ interconnectedness with other institutions and markets, 
and the possibility for negative externalities--may create a conflict 
of interest between shareholders (managers) of important financial 
institutions and taxpayers with respect to the optimal level of risk-
taking. In other words, shareholders may enjoy the upside of risk-
taking actions whereas taxpayers and other stakeholders have to bear 
the costs associated with such risk-taking. While the literature does 
not specifically reference BDs and IAs, but rather the financial 
services sector more generally, the SEC believes that the global point 
may be applicable to BDs and IAs given that these entities constitute a 
segment of the financial services sector. In addition, many BDs and IAs 
that would be covered by the proposed rule are subsidiaries of bank 
holding companies and as such these studies may be relevant for them. 
Thus, for BDs and IAs the use of options in compensation arrangements 
could potentially amplify this conflict of interest as it provides 
covered persons with an asymmetric payoff structure and an incentive to 
undertake risks that may be optimal from shareholders' point of view 
but may provide risk-taking incentives to management that could lead to 
higher likelihood of default at these institutions and potentially 
increase the risk to the greater financial system. Consequently, 
capping the use of stock options and curbing covered persons' 
incentives for inappropriate risk-taking at BDs and IAs could decrease 
their likelihood of default, better align managers' incentives with 
those of a broader group of stakeholders and limit potential negative 
externalities generated by the default of particularly important 
institutions.\427\ However, although BDs and IAs are financial 
institutions, any generalization based on the findings in the 
literature may not be very accurate because BDs and IAs also have some 
differences with respect to other financial institutions. For example, 
BDs and IAs differ from other financial institutions with respect to 
business models, nature of the risks posed by the institutions, and the 
nature and identity of the persons affected by those risks.
---------------------------------------------------------------------------

    \426\ See Bolton, P., Mehran, H., Shapiro, J. 2011. Executive 
Compensation and Risk Taking. Federal Reserve Bank of New York Staff 
Reports, available at: https://www.newyorkfed.org/medialibrary/media/research/staff_reports/sr456.pdf. The report shows the 
significant difference between the composition of financing for the 
average non-financial firm (having about 40% of debt on its balance 
sheet), as opposed to the average financial institution (having at 
least 90% of debt on its balance sheet).
    \427\ See French et al., 2010. The Squam Lake Report: Fixing the 
Financial System. Journal of Applied Corporate Finance 22, 8-21; and 
McCormack, J., Weiker, J. 2010. Rethinking `Strength of Incentives' 
for Executives of Financial Institutions. Journal of Applied 
Corporate Finance 22, 25-72.
---------------------------------------------------------------------------

    To the extent that the asymmetric payoff structure of options 
encourages covered persons at BDs and IAs to undertake risks that are 
also suboptimal from a shareholders' point of view, the proposed rule's 
limitation on the use of options as part of compensation arrangements 
may also improve incentive alignment between executives and 
shareholders. However, as discussed in the Broad Economic 
Considerations section, executives may be reluctant to undertake value-
increasing but risky projects due to the undiversified nature of their 
wealth and as such may engage in actions that lower firm value (i.e., 
forgo risky but value-increasing projects). For example, an economic 
study found that low sensitivity of compensation to risk resulted in a 
loss of firm value due to suboptimal risk-taking by executives in these 
companies.\428\ Mechanisms that are put in place to curb such undesired 
behavior by executives include incentive-based compensation components 
whose value is generally increasing in risk, such as stock options. 
Thus, risk-taking incentives induced by options may be valuable in 
order to provide covered persons at BDs and IAs with incentives to take 
risks that are desirable by shareholders. As a consequence, a potential 
cost of the proposed limit to the use of stock options in incentive-
based compensation arrangements at covered institutions is the 
potential for such limit to generate sub-optimally low risk-taking 
incentives for the covered persons at BDs and IAs, potentially leading 
to lower shareholder values for these institutions.
---------------------------------------------------------------------------

    \428\ See Low, A., 2009. Managerial risk-taking behavior and 
equity-based compensation. Journal of Financial Economics 92, 470-
490. The study examines changes in risk-taking by CEOs whose firms 
have become more protected from a takeover due to a change in anti-
takeover laws. The study finds that CEOs with compensation 
arrangements with a low sensitivity of compensation to volatility 
decrease risk-taking following the adoption of the anti-takeover 
law, and that such a decrease in risk-taking activity is value 
destroying. The study also shows that as a response, firms increase 
the sensitivity of CEO compensation to volatility to encourage risk-
taking following the adoption of the anti-takeover law.
---------------------------------------------------------------------------

    Limiting the amount of stock option based compensation that can 
qualify for mandatory deferral at 15 percent suggests that a covered 
institution could theoretically award up to 55 percent of its annual 
incentive-based compensation in the form of stock options (for senior 
executive officers and significant risk-takers at Level 1 and Level 2 
covered institutions). Based on the SEC's baseline analysis, it appears 
that the use of options is increasingly infrequent in incentive-based 
compensation arrangements at public parent institutions of BDs and IAs. 
Stock options at Level 1 covered institutions represent about 4 percent 
of total incentive-based compensation, while at Level 2 covered 
institutions they represent about 20 percent.
    If the compensation structure of BDs and IAs is similar to that of 
their parent institutions, and the compensation structure of private 
institutions is similar to that of public institutions, the specific 
restriction imposed by the proposed rule would be unlikely to affect 
the usage of options at Level 1 or unconsolidated Level 2 BDs and IAs 
and would likely result in insignificant compliance costs. On the other 
hand, if the compensation practices of parent institutions are 
significantly different from those at their subsidiaries, covered BDs 
and IAs could experience

[[Page 37788]]

significant compliance costs when implementing the specific requirement 
of the proposed rule. Since the SEC does not have data on how many 
covered IAs have parent institutions, it is also possible that a 
significant number of these IAs may be stand-alone companies and 
therefore could have higher costs to comply with this specific 
requirement of the proposed rule compared to covered IAs and BDs that 
are part of reporting parent institutions.
    As discussed above, BDs and IAs could also incur direct economic 
costs such as decrease in firm value if the proposed rule leads to 
lower than optimal use of options in senior executive officers and 
significant risk-takers incentive-based compensation arrangements. The 
same holds true if the compensation of BDs and IAs is generally 
different than that of banking institutions, which most of their parent 
institutions are. Lastly, because some BDs and IAs are subsidiaries of 
private parent institutions, if there is a significant difference in 
the compensation practices of public and private covered institutions 
such BDs and IAs could face large compliance costs and direct economic 
costs. The SEC does not have data for the use of options at 
subsidiaries of Level 1 or Level 2 parents, and thus cannot quantify 
the impact of the proposed rule on those institutions. To better assess 
the effects of options on compliance costs for BDs and IAs, the SEC 
requests comments on the use of options in the compensation structures 
of BDs and IAs below.
    The Agencies could have selected as an alternative not to place a 
limit on the use of stock options to meet the minimum required deferral 
amount requirement for a performance period. Such an alternative would 
provide covered persons at BDs and IAs with more incentives to 
undertake risks compared to the alternative the SEC has chosen in the 
proposed rule. Taxpayers would potentially be worse off under the 
alternative since the combination of high leverage and government 
guarantees, coupled with additional risk-taking incentives from stock 
options could lead to inappropriate risk-taking from taxpayers' point 
of view. Such an alternative likely would have led to a higher 
probability of default at covered institutions. For important 
institutions, such an alternative would also increase the likelihood of 
risks at the institution also propagating to the greater financial 
system. On the other hand, it is possible that shareholders would 
potentially prefer increased risk-taking and as a consequence 
compensation arrangements that encourage such behavior. From the SEC's 
baseline analysis, provided that BDs and IAs have similar compensation 
arrangements as their parents, the proposed rule should not 
significantly affect existing compensation arrangements of covered 
institutions.
3. Long-Term Incentive Plans
    For senior executive officers and significant risk-takers at Level 
1 and Level 2 covered institutions the proposed rule would require a 
minimum deferral period and a minimum deferral percentage amount of 
incentive-based compensation awarded through long-term incentive plans 
(LTIPs), where LTIPs are characterized by having a performance 
measurement period of at least three years. The proposed rule would 
require deferral of 60 percent (50 percent) of LTIP awards for senior 
executive officers of Level 1 (Level 2) covered institutions, and 
deferral of 50 percent (40 percent) of LTIP awards for significant 
risk-takers of Level 1 (Level 2) covered institutions. The deferral 
period for deferred LTIPs must be at least two years for covered 
persons of Level 1 covered institutions and at least one year for 
covered persons of Level 2 covered institutions.
    LTIPs are designed to reward long-term performance, performance 
that is usually measured over the three-years following the beginning 
of the performance period.\429\ Thus, these plans reward long-term 
performance outcomes and as such generate incentives for long-term 
value. LTIP awards can be in the form of cash or stock and these awards 
occur at the end of the performance period. The amount of the award 
depends on the degree to which the company meets some predetermined 
performance milestones. These performance milestones can include a 
variety of accounting-based performance measures, such as sales and 
earnings, and research shows that the choice of performance measures is 
related to company specific strategic goals.\430\ Requiring a minimum 
percentage of LTIP awards to be deferred would lengthen the period over 
which senior executive officers and significant risk-takers receive 
compensation under these plans and subject such compensation to 
downward adjustment during the performance measurement period (prior to 
the award) as well as forfeiture and clawback during the deferral and 
post-deferral periods respectively. Some studies have criticized LTIPs 
for having short performance periods.\431\ The limited economic 
literature on LTIPs currently does not provide a clear indication of 
the effect of LTIPs on excessive risk-taking. The only study that 
investigates the role of LTIPs \432\ suggests that companies that use 
them experience improvement in operating performance and their NEOs do 
not appear to take higher risks. Similar to the discussion on the 
benefits and costs of mandatory deferral of other forms of incentive-
based compensation, deferral of the LTIP award could allow for long-
term risks taken by BD and IA senior executive officers and significant 
risk-takers to materialize and thus for their compensation to be more 
appropriately adjusted for the risks they have taken. LTIP deferral may 
decrease risk-taking because covered persons may have an incentive to 
manage the institution such that they receive their full compensation 
under these plans. If the additional deferral of LTIPs lowers risk-
taking incentives at covered BDs and IAs to suboptimally low levels, 
then firm value at these institutions could suffer as a consequence. 
However, if the additional deferral of LTIPs mitigates incentives for 
inappropriate risk-taking at covered BDs and IAs, then such outcome 
would lower the likelihood of default at these institutions, better 
align managers' incentives with those of a broader group of 
stakeholders, and also lower the likelihood of negative externalities.
---------------------------------------------------------------------------

    \429\ See Frederic W. Cook & Co., Inc. The 2014 Top 250 Report: 
Long-term incentive grant practices for executives.
    \430\ See Li and Wang (2014).
    \431\ See The alignment gap between creating value, performance 
measurement, and long-term incentive design, IRRCI research report, 
2014.
    \432\ See Li and Wang, 2014.
---------------------------------------------------------------------------

    As an alternative, the Agencies could have selected a larger 
fraction of LTIPs to be deferred (e.g., more than 60 percent for senior 
executive officer at a Level 1 covered institution) and increased the 
LTIPs' deferral period (e.g., for more than two years for senior 
executive officers and significant risk-takers at Level 1 covered 
institutions). A longer deferral period for LTIPs would prolong the 
exposure of senior executive officers' and significant risk-takers' 
compensation to adverse outcomes of their actions. If outcomes of some 
inappropriate risks are only realized in the longer-term, then 
prolonging the deferral period for LTIPs would provide incentives to 
senior executive officers and significant risk-takers to avoid such 
actions. On the other hand, such an alternative might have exposed 
senior executive officers and significant risk-takers to outcomes of 
actions that they are less likely to have been responsible for. 
Additionally, long deferral period for LTIPs could create potential

[[Page 37789]]

liquidity issues for senior executive officers and significant risk-
takers since their compensation cannot be cashed out on a timely basis 
to meet their liquidity needs.\433\ It is also possible that a long 
deferral period for LTIPs would create incentives for institutions to 
pay higher fixed pay and as a consequence distort the value-enhancing 
incentives that are generated through variable pay.
---------------------------------------------------------------------------

    \433\ Interest rates charged to covered persons on loans used to 
cover their liquidity needs could proxy for the related cost stated 
in the text. Such costs are likely to be determined by multiple 
factors (for example, the macroeconomic environment) and vary over 
time and by individuals making them difficult to quantify.
---------------------------------------------------------------------------

    As another alternative, the Agencies could have decided to exclude 
LTIPs from the amount of incentive-based compensation that is to be 
deferred in a given year. Such an alternative could have excluded a 
major part of covered persons' incentive-based compensation 
arrangements from the deferred amount. LTIPs typically have a 
performance period of three years, which is shorter than the deferral 
period proposed in the rulemaking. Under this alternative, not 
including LTIPs as part of the deferred amount may have limited the 
ability of the proposed rule to curb inappropriate risk-taking. 
However, if the current use of LTIPs by covered institutions is 
consistent with generating optimal risk-taking incentives from the 
perspective of certain shareholders, then not subjecting LTIPs to 
mandatory deferral would maintain these value-enhancing incentives.
4. Downward Adjustment and Forfeiture
    For senior executive officers and significant risk-takers at Level 
1 and Level 2 covered institutions, the rule proposes placing at risk 
of downward adjustment all incentive-based compensation amounts not yet 
awarded for the current performance period and at risk of forfeiture 
all deferred but not yet vested incentive-based compensation. As the 
analysis in the baseline section suggests, the triggers for downward 
adjustment and forfeiture consist of adverse outcomes such as poor 
financial performance due to significant deviations from approved risk 
parameters, inappropriate risk-taking (regardless of the impact on 
financial performance), risk management or control failures, and non-
compliance with regulatory and supervisory standards resulting in 
either legal action against the covered institution or a restatement to 
correct a material error. The compensation of covered persons with 
either direct accountability or failure of awareness of an undesirable 
action would be subject to downward adjustment and/or forfeiture.
    With regard to the determination of the compensation amount to be 
downward adjusted or forfeited, the proposed rule would condition the 
magnitude of the adjustment or forfeiture amounts on both the intent 
and the participation of covered persons in the event(s) triggering the 
review, as well as the magnitude of costs generated by the related 
actions (including financial performance, fines and litigation and 
related reputational damage). Compensation would be subject to downward 
adjustment and forfeiture during the performance period and the 
deferral period, respectively. As a consequence, this requirement would 
provide incentives to senior executive officers and significant risk-
takers at BDs and IAs to avoid inappropriate risk-taking since they 
could be penalized in situations where inappropriate risks had been 
undertaken, regardless of whether such risks resulted in poor 
performance.
    The downward adjustment or forfeiture amounts is conditional on the 
intent, responsibility and the magnitude of the financial loss caused 
to the covered institution by inappropriate actions of covered persons. 
In other words, the penalty imposed on the covered person would 
increase with the intent, responsibility and the magnitude of financial 
loss generated. This ``progressiveness'' characteristic in the proposed 
rule requirement would imply that the covered person's incentive-based 
compensation award would be increasingly at stake. Thus, covered 
persons would be expected to have incentives to avoid excessive risk-
taking in order to secure at least part of incentive-based compensation 
award.
    Additionally, provided that senior executive officers and 
significant risk-takers at BDs and IAs may be deemed accountable and 
risk their compensation for inappropriate actions that were undertaken 
by other executives or significant risk-takers, they may have an 
incentive to establish an effective governance system that would 
monitor risk exposure. Such an incentive and the corresponding actions 
would strengthen risk oversight within the covered institution and 
potentially lower the probability that any inappropriate action taken 
might go undetected. To this point, a recent economic study indicates 
that bank holding companies with strong risk controls, as proxied by 
the presence of an independent and strong risk committee, were found to 
be exposed to lower tail risk, lower amount of underperforming loans, 
and had better operating and financial performance during the financial 
crisis.\434\
---------------------------------------------------------------------------

    \434\ See Ellul, A., Yerramilli, V. 2013. Stronger Risk 
Controls, Lower Risk: Evidence from U.S. Bank Holding Companies. 
Journal of Finance 68, 1757-1803.
---------------------------------------------------------------------------

    On the other hand, the risk of downward adjustment and forfeiture 
could increase uncertainty on covered persons' expectations for 
receiving the compensation. A possibility exists that risks a covered 
person believes ex-ante to be appropriate may be classified as ex-post 
inappropriate and thus trigger downward adjustment or forfeiture of 
related compensation. Such uncertainty about the interpretation of 
appropriate risk-taking could generate incentives for managers to take 
approaches with respect to risk-taking that are not optimal from the 
perspective of shareholders. Such an avoidance of risks, if it occurs, 
could lead to lower firm value and losses for shareholders.
    Based on the SEC's baseline analysis of current compensation 
practices, it appears that all of the Level 1 public parent 
institutions and most of the Level 2 public parent institutions already 
employ forfeiture with respect to deferred compensation. The forfeiture 
rules are based on various triggers and apply to NEOs, non-NEOs and 
significant risk-takers. Thus, if the compensation structure of BDs and 
IAs is similar to that of their parent institutions, and the 
compensation structure of private institutions is similar to that of 
public institutions, the implementation of the proposed rule related to 
forfeiture would be unlikely to lead to significant compliance costs. 
On the other hand, if the compensation practices of parent institutions 
are significantly different than those at their subsidiaries (e.g., BDs 
and IAs do not use downward adjustment and forfeiture in their 
compensation packages), covered BDs and IAs could experience 
significant compliance costs when implementing this specific 
requirement of the proposed rule. Since the SEC does not have data on 
how many covered IAs have parent institutions, it is also possible that 
a significant number of these IAs may be stand-alone companies and 
therefore could have higher costs to comply with this specific 
requirement of the proposed rule compared to covered IAs and BDs that 
are part of reporting parent institutions. BDs and IAs could also incur 
direct economic costs such as decrease in firm value if the proposed 
rule requirements regarding downward adjustment or forfeiture lead to 
less risk-taking than is optimal from shareholders' point of view. The 
same

[[Page 37790]]

holds true if the compensation of BDs and IAs is generally different 
than that of banking institutions, which most of their parent 
institutions are.
    Lastly, because some BDs and IAs are subsidiaries of private parent 
institutions, if there is a significant difference in the compensation 
practices of public and private covered institutions such BDs and IAs 
could face large compliance costs and direct economic costs. The SEC 
does not have data for the use of downward adjustment and forfeiture at 
subsidiaries of Level 1 or Level 2 parents, and thus cannot quantify 
the impact of the rule for those institutions. To better assess the 
effects of downward adjustment and forfeiture on compliance costs for 
BDs and IAs. The SEC requests comments below.
5. Clawback
    For senior executive officers and significant risk-takers at Level 
1 and Level 2 covered institutions, the proposed rule would require 
clawback provisions in incentive-based compensation arrangements to 
provide for the recovery of paid compensation for up to seven years 
following the vesting date of such compensation. Such a clawback 
requirement would be triggered when senior executive officers and 
significant risk-takers are determined to have engaged in fraud, 
intentional misrepresentation of information used to determine a 
covered person's incentive-based compensation, or misconduct resulting 
in significant financial or reputational harm to the covered 
institution. Other existing provisions of law contain clawback 
requirements that potentially have some overlap with those in the 
proposed rulemaking. Thus, certain covered institutions may have 
experience with recovering executive compensation via clawback. For 
example, section 304 of the Sarbanes Oxley Act (``SOX'') contains a 
recovery provision that is triggered when a restatement occurs as a 
result of issuer misconduct. This provision applies only to the chief 
executive officer (``CEO'') and chief financial officer (``CFO'') and 
the amount of required recovery is limited to compensation received in 
the year following the first improper filing.\435\ The Interim Final 
Rules under section 111 of the Emergency Economic Stabilization Act of 
2008 (``EESA'') required institutions receiving assistance under TARP 
to mandate Senior Executive Officers to repay compensation if awards 
based on statements of earnings, revenues, gains, or other criteria 
that were later found to be materially inaccurate.\436\ Relative to 
either SOX or EESA, the clawback requirement of the proposed rule is 
more expansive in that its application is not only limited to CEOs and 
CFOs but would cover any senior executive officer and significant risk-
taker in a Level 1 or Level 2 covered institution. In addition to the 
broader scope of the clawback provision in the proposed rule regarding 
covered persons, there is also a broader scope with respect to the 
circumstances that would trigger clawback. More specifically, the 
proposed rule includes misconduct that resulted in reputational or 
financial harm to the covered institution as a trigger for clawback.
---------------------------------------------------------------------------

    \435\ See 15 U.S.C. 7243.
    \436\ Under EESA a ``Senior Executive Officer'' was defined as 
an individual who is one of the top five highly paid executives 
whose compensation was required to be disclosed pursuant to the 
Securities Exchange Act of 1934. See Department of Treasury, TARP 
Standards for Compensation and Corporate Governance; Interim Final 
Rule (June 15, 2009), available at http://www.gpo.gov/fdsys/pkg/FR-2009-06-15/pdf/E9-13868.pdf.
---------------------------------------------------------------------------

    The inclusion of the clawback provision in the incentive-based 
compensation of senior executive officers and significant risk-takers 
at BDs and IAs could increase the horizon of accountability with 
respect to the identified actions that are likely to bring harm to the 
covered institution. As a consequence of the clawback horizon, senior 
executive officers and significant risk-takers are likely to have lower 
incentives to engage in actions that may put the covered institution at 
risk in the longer run. Moreover, the proposed rule may also increase 
incentives to senior executive officers and significant risk-takers to 
put in place stronger mechanisms such as governance in an effort to 
protect their incentive-based compensation from events that may trigger 
a clawback. Finally, in addition to lowering the incentives of senior 
executive officers and significant risk-takers for undesirable actions 
that may harm the covered institution, stakeholders of the covered 
institution are also expected to benefit from the clawback provision 
since in the event of an action triggering a clawback, any recovered 
incentive-based compensation amount would accrue to the institution.
    The fact that incentive-based compensation is to a large extent 
determined by reported performance, coupled with the lowered incentives 
for covered persons to intentionally misrepresent information, can lead 
to improved financial reporting quality for covered institutions. Thus, 
indirectly the potential to claw back incentive-based compensation that 
is awarded on erroneous financial information could generate incentives 
for high quality reporting. The literature finds that market penalties 
for reporting failures, as captured by restatements of financial 
reports, i.e., financial reports of (extremely) low quality, are non-
trivial and may translate into an increase in the cost of capital for 
such firms.\437\ To the extent that the quality of financial reporting 
increases as a result of the proposed rule, capital formation may be 
fostered since the improved information environment may lead to a 
decrease in the cost of raising capital for covered institutions.\438\
---------------------------------------------------------------------------

    \437\ See Palmrose, Z., Richardson, V., Scholz, S. 2004. 
Determinants of Market Reactions to Restatement Announcements. 
Journal of Accounting and Economics 37, 59-89. This study observes 
an average abnormal return of -9% over the 2-day restatement 
announcement window for a sample of restatements announced over the 
1995-1999 period.
    See Hribar, P., Jenkins, N. 2004. The Effect of Accounting 
Restatements on Earnings Revisions and the Estimated Cost of 
Capital. Review of Accounting Studies 9, 337-356. This study 
observes a significant increase in the cost of capital for firms 
that restated their financial reports due to lower perceived 
earnings quality and an increase in investors' required rate of 
return.
    \438\ See Francis, J., LaFond, R., Olsson, P., Schipper, K. 
2005. The Market Pricing of Accruals Quality. Journal of Accounting 
and Economics 39, 295-327. This study observes a negative relation 
between measures of earnings quality and costs of debt and equity. 
The study focuses on the accrual component of earnings to infer 
earnings quality since this component of earnings involves more 
discretion in its estimation and is more prone to be manipulated by 
firms.
---------------------------------------------------------------------------

    However, the relatively long clawback horizon may generate 
uncertainty regarding incentive-based compensation of senior executive 
officers and significant risk-takers. For example, that could be the 
case if certain actions that trigger a clawback are outside of a 
covered person's control. As a response to the potentially increased 
uncertainty, senior executive officers and significant risk-takers may 
demand higher levels of overall compensation, or substitution of 
incentive-based compensation with other forms of compensation such as 
salary. Such potential may distort incentives for risk-taking and as a 
consequence lower shareholder value. Also, the increased allocation of 
resources to the production of high-quality financial reporting may 
divert resources from other activities that may be value enhancing. 
Finally, covered persons may have a decreased incentive to pursue those 
projects that would require more complex accounting judgments, perhaps 
lowering shareholder value.\439\
---------------------------------------------------------------------------

    \439\ For example, if an executive is under pressure to meet an 
earnings target, rather than manage earnings through accounting 
judgments, the executive may elect to reduce or defer to a future 
period research and development or advertising expenses. This could 
improve reported earnings in the short-term, but could result in a 
suboptimal level of investment that adversely affects performance in 
the long run. See Chan, L., Chen, K., Chen, T., Yu, Y. 2012. The 
effects of firm-initiated clawback provisions on earnings quality 
and auditor behavior. Journal of Accounting and Economics 54, 180-
196.

---------------------------------------------------------------------------

[[Page 37791]]

    Moreover, the potential compliance costs related with the 
implementation of the clawback provision could be significant. For 
example, covered institutions may have to rely on the work of outside 
experts to estimate the amount of incentive-based compensation to be 
clawed back following a clawback trigger.
    Based on the SEC's baseline analysis, it appears that all of the 
Level 1 covered institutions and most of the Level 2 covered 
institutions already employ clawback policies with respect to deferred 
compensation. The clawback policies are based on various triggers and 
apply to NEOs, non-NEOs and significant risk-takers. Thus, if the BDs 
and IAs have similar policies on clawback, and the compensation 
structure of private institutions is similar to that of public 
institutions, the implementation of the proposed clawback rule would 
unlikely lead to significant compliance costs. On the other hand, if 
the compensation practices of parent institutions are significantly 
different than those at their subsidiaries (e.g., BDs and IAs do not 
include clawback policies in their compensation packages), covered BDs 
and IAs could experience significant compliance costs when implementing 
the proposed rule. The same holds true if the compensation of BDs and 
IAs is generally different than that of banking institutions, which 
most of their parent institutions are. Additionally, since the SEC does 
not have data on how many covered IAs have parent institutions, it is 
also possible that a significant number of these IAs may be stand-alone 
companies and therefore could have higher costs to comply with this 
specific requirement of the proposed rule compared to covered IAs and 
BDs that are part of reporting parent institutions.
    The SEC has attempted to quantify such costs using data in Table 
14. We note that these costs are not necessarily going to be in 
addition to the compliance costs discussed above, as covered 
institutions may hire a compensation consultant to help them with 
several requirements in the proposed rules.
    Lastly, because some BDs and IAs are subsidiaries of private parent 
institutions, if there is a significant difference in the compensation 
practices of public and private covered institutions such BDs and IAs 
could face large compliance costs. The SEC does not have data for the 
use of clawback at subsidiaries of Level 1 or Level 2 parents, and thus 
cannot quantify the impact of the rule on those institutions. To better 
assess the effects of clawback on compliance costs for BDs and IAs the 
SEC requests detailed comments below.
6. Hedging
    The proposed rule would prohibit the purchase of any instrument by 
a Level 1 or Level 2 covered institution to hedge against any decrease 
in the value of a covered person's incentive-based compensation. As 
discussed above, introducing a minimum mandatory deferral period for 
incentive-based compensation aims at increasing long-term managerial 
accountability, including long-term risk implications associated with 
covered persons' actions. Using instruments to hedge against decreases 
in firm value would provide downside insurance to covered persons' 
wealth, including equity holdings that are part of deferred 
compensation. If the value of (deferred) incentive-based compensation 
is protected from potential downside through a hedging transaction, 
this is likely to increase the covered person's tolerance to risk. 
Thus, the effect of compensation deferral would likely be 
weakened.\440\ For BDs and IAs that currently initiate hedges on behalf 
of their covered persons, a benefit from the prohibition on hedging is 
that the incentives of covered persons to exert effort could be 
strengthened given the same compensation contract. This in turn would 
imply a stronger alignment between executives' and taxpayers' and other 
stakeholders' interests for the same amount of performance-based pay.
---------------------------------------------------------------------------

    \440\ See Bebchuk, L., Fried. J. Paying for long-term 
performance. University of Pennsylvania Law Review 158, 1915-1959. 
The paper argues that potential benefits from tying executive 
compensation to long-term shareholder value are weakened when 
executives are allowed to hedge against downside risk.
    See also Gao, H. 2010. Optimal compensation contracts when 
managers can hedge. Journal of Financial Economics 97, 218-238. This 
study shows that the ability to hedge against potential downside 
makes the executive more risk tolerant. In other words, holding the 
compensation arrangement constant, hedging is predicted to weaken 
the sensitivity of compensation to performance and also the 
sensitivity of compensation to risk. However, the study also shows 
that for executives who can engage in low-cost hedging transactions, 
compensation contracts tend to provide higher sensitivity of 
executive pay to both performance and volatility.
---------------------------------------------------------------------------

    While the proposed rule intends to eliminate firm initiated 
hedging, a personal hedging transaction by covered persons would still 
be permitted (unless the institution prohibits such transactions from 
occurring). Thus, a covered person at BDs and IAs could potentially 
substitute the firm-initiated hedge with a personal hedging \441\ 
contract and restore any changes in incentives from the prohibition of 
the firm-initiated hedge.
---------------------------------------------------------------------------

    \441\ Refer to Tables 7a and 7b for statistics regarding the 
complete prohibition of hedging by parent institutions of BDs and 
IAs.
---------------------------------------------------------------------------

    To the extent that the covered person's compensation contract is 
not adjusted as a response to the elimination of the hedge, the covered 
person would face stronger incentives to exert effort whereas her 
tolerance for risk-taking would decrease with the prohibition on 
hedging. Whether the resulting lower risk-taking tolerance is 
beneficial for BDs and IAs is difficult to determine. On one hand, if 
the covered persons' risk-taking incentives are at an optimal level 
with the hedging transaction in place, then eliminating the hedge may 
reduce their risk-taking incentives to levels that could be detrimental 
for shareholder value. If this were the case, however, the 
institution's compensation committees could adjust compensation 
structures in a manner to achieve pre-prohibition risk-taking 
incentives if the distortion from hedging prohibition is deemed to be 
detrimental to firm value; however, some provisions of the proposed 
rule could potentially constrain board of directors' flexibility to 
make such adjustments.\442\ On the other hand, if covered persons had 
incentives to undertake undesirable risks given the downside protection 
provided by the hedge, then eliminating such protection could lead them 
to engage in risk-taking which could lead to higher firm values.
---------------------------------------------------------------------------

    \442\ For example, boards of directors or compensation 
committees at covered BDs and IAs would be constrained from 
increasing the risk-taking incentives of covered persons through the 
additional provision of stock options, if banning hedging lowers 
risk-taking incentives to a sub-optimal level.
---------------------------------------------------------------------------

    Based on the SEC's baseline analysis, it appears that most Level 1 
covered institutions (70 percent) and Level 2 covered institutions (60 
percent) are already using prohibition on hedging with respect to 
executive compensation of executives and significant risk-takers. 
Additionally, 70 percent of Level 1 covered institutions and 100 
percent of Level 2 covered institutions already prohibit hedging with 
respect to executive compensation of non-employee directors. If BDs and 
IAs have similar policies as their parent institutions, and the 
compensation structure of private institutions is similar to that of 
public institutions, the

[[Page 37792]]

implementation of the proposed rule in its part related to the 
prohibition of hedging is unlikely to lead to significant compliance 
costs. The cost of compliance with the proposed requirement of the rule 
would mostly affect the few BDs and IAs whose parent institutions do 
not currently implement such a prohibition. On the other hand, if the 
compensation practices of parent institutions are significantly 
different than those at their subsidiaries (e.g., BDs and IAs do not 
prohibit hedging), covered BDs and IAs could experience significant 
compliance costs when implementing the proposed rule. Since the SEC 
does not have data on how many covered IAs have parent institutions, it 
is also possible that a significant number of these IAs may be stand-
alone companies and therefore could have higher costs to comply with 
this specific requirement of the proposed rule compared to covered IAs 
and BDs that are part of reporting parent institutions. BDs and IAs 
could also incur direct economic costs such as decrease in firm value 
if the proposed prohibition on hedging leads to less risk-taking than 
is optimal. The same holds true if the compensation of BDs and IAs is 
generally different than that of banking institutions, which most of 
their parent institutions are. If BDs and IAs do not prohibit hedging 
and this provides incentives to their covered persons to undertake 
undesirable risks because of the downside protection provided by the 
hedge, then applying the rule provisions could lead to more appropriate 
risk-taking.
    Lastly, because some BDs and IAs are subsidiaries of private parent 
institutions, if there is a significant difference between the 
compensation practices of public and private covered institutions such 
BDs and IAs could face large compliance costs and direct economic 
costs. The SEC does not have data for a prohibition of hedging at 
subsidiaries of Level 1 or Level 2 private parents, and thus cannot 
quantify the impact of the rule on those institutions. To better assess 
the effects of the prohibition on hedging on compliance costs for BDs 
and IAs the SEC requests comments below.
    As an alternative, some commenters suggested disclosure of hedging 
transactions instead of prohibition.\443\ One commenter suggested 
instead of prohibiting the use of hedging instruments to require full 
disclosure of all outside transactions in financial markets by covered 
persons, including hedging transactions, to the extent that these 
transactions affect pay-performance sensitivity.\444\ This disclosure 
should be made to the compensation committee of the board of directors 
and the appropriate regulator, and the board of directors should attest 
to the fact that these transactions do not distort proper risk-reward 
balance in the compensation arrangement. According to the commenter, 
sometimes covered persons may have legitimate purposes for engaging in 
hedging transactions such as when they are exposed excessively to the 
riskiness of the covered institution and need to rebalance their 
personal portfolio. Such an alternative, however, might not prevent 
covered persons from unwinding the effect of the mandatory deferral. 
For example, it would not be easy to disentangle hedging transactions 
that diminish individuals' exposure to the riskiness of the covered 
institutions from transactions that reverse the effect of the deferral. 
Additionally, the compensation committee might not have the expertise 
to evaluate complex derivatives transactions.
---------------------------------------------------------------------------

    \443\ See CFP, FSR, SIFMA.
    \444\ See CFP.
---------------------------------------------------------------------------

7. Maximum Incentive-Based Compensation Opportunity
    The proposed rule would prohibit Level 1 and Level 2 covered 
institutions from awarding incentive-based compensation to senior 
executive officers and significant risk-takers in excess of 125 percent 
(for senior executive officers) or 150 percent (for significant risk-
takers) of the target amount for that incentive-based compensation. 
Placing a cap on the amount by which the incentive-based compensation 
award can exceed the target would essentially limit the upside pay 
potential due to performance and a potential impact of such restriction 
could be to lower risk-taking incentives by senior executive officers 
and significant risk-takers. That could be the case because the cap on 
incentive-based compensation implies that managers would not be 
rewarded for performance once the cap is reached.
    As discussed above, high levels of upside leverage could lead to 
senior executive officers and significant risk-takers taking 
inappropriate risks to maximize the potential for large amounts of 
incentive-based compensation. Given the positive link between risk and 
expected payoffs from managerial actions, a potential impact of such 
restriction could be to lower risk-taking incentives by senior 
executive officers and significant risk-takers. Whether such an effect 
is beneficial or not for covered BDs and IAs firm value is likely to 
depend on many factors including the level of the incentive-based 
compensation targets set in compensation arrangements. If the proposed 
cap excessively lowers appropriate risk-taking incentives, then firm 
value could suffer. Moreover, another potential cost from the proposed 
restriction is that effort inducing incentives may be diminished once 
the cap is achieved, possibly misaligning the interests of shareholders 
with those of managers. On the other hand, if the cap on incentive-
based compensation awards eliminates a range of payoffs that could only 
be achieved by actions associated with taking suboptimally high risks, 
then such a restriction would improve firm value.
    As the baseline analysis shows, the maximum incentive-based 
compensation opportunity for Level 1 parent institutions is on average 
155 percent and that for Level 2 parent institutions is on average 190 
percent. Both are significantly higher than would be permitted under 
the proposed rule. If BDs and IAs have similar policies as their parent 
institutions, and the compensation structure of private institutions is 
similar to that of public institutions, the implementation of the 
proposed rule in its part related to maximum incentive-based 
compensation opportunity could lead to significant compliance costs. 
The cost could result from changing the current practices and, as a 
result, potentially having to compensate senior executive officers and 
significant risk-takers for the decreased ability to earn compensation 
in excess of the target amount. If the current compensation practices 
with regard to maximum incentive-based compensation opportunity are 
optimal, it is possible than affected BDs and IAs could experience loss 
of human capital. On the other hand, as discussed above, if the cap on 
incentive-based compensation awards eliminates a range of payoffs that 
could only be achieved by actions associated with taking suboptimally 
high risks, then such a restriction would improve firm value. Since the 
SEC does not have data on how many covered IAs have parent 
institutions, it is also possible that a significant number of these 
IAs may be stand-alone companies and therefore could have higher costs 
to comply with this specific requirement of the proposed rule compared 
to covered IAs and BDs that are part of reporting parent institutions.
    Additionally, because some BDs and IAs are subsidiaries of private 
parent institutions, if there is a significant difference between the 
compensation practices of public and private covered

[[Page 37793]]

institutions such BDs and IAs could face large compliance costs when 
applying this rule requirement. The SEC does not have data on the use 
of maximum incentive-based compensation opportunity at subsidiaries of 
Level 1 or Level 2 private parents, and thus cannot quantify the impact 
of the rule on those institutions. To better assess the effects of the 
proposed limitations to the maximum incentive-based compensation 
opportunity on compliance costs for BDs and IAs the SEC requests 
comments below.
8. Acceleration of Payments
    The proposed rule would prohibit the acceleration of payment of 
deferred regulatory incentive-based compensation except in cases of 
death or disability of covered persons at Level 1 and Level 2 covered 
institutions. This would prevent covered institutions from undermining 
the effect from the mandatory deferral of incentive-based compensation 
by accelerating the deferred payments to covered persons. It could, 
however, negatively affect covered persons that decide to leave the 
institution in search for other employment opportunities. In such 
cases, these covered persons might have to forgo a significant portion 
of their compensation.
    As the analysis in the Baseline section shows, most Level 1 parent 
institutions (approximately 70 percent) already prohibit acceleration 
of payments to their executives, while very few of the Level 2 parent 
institutions do. The only exceptions are in cases of death or 
disability. Given that current practices of BDs' and IAs' Level 1 
parent institutions already apply most of the prohibitions required by 
the proposed rule (except employment termination), if those BDs and IAs 
have similar policies as their parent institutions, and the 
compensation structure of private institutions is similar to that of 
public institutions, the implementation of the proposed with respect to 
the prohibition on the acceleration of payments is unlikely to lead to 
significant compliance costs. The cost of compliance with the 
requirement of the rule will mostly affect the BDs and IAs whose parent 
institutions are Level 2 covered institutions or Level 1 covered 
institutions that do not currently implement such a prohibition. On the 
other hand, if the compensation practices of parent institutions are 
significantly different than those at their subsidiaries (e.g., BDs and 
IAs do not prohibit acceleration of payments), covered BDs and IAs 
could experience significant compliance costs when implementing the 
proposed rule. Additionally, since the SEC does not have data on how 
many covered IAs have parent institutions, it is also possible that a 
significant number of these IAs may be stand-alone companies and 
therefore could have higher costs to comply with this specific 
requirement of the proposed rule compared to covered IAs and BDs that 
are part of reporting parent institutions.
    Lastly, because some BDs and IAs are subsidiaries of private parent 
institutions, if there is a significant difference in the compensation 
practices of public and private covered institutions such BDs and IAs 
could face large compliance costs when applying this rule requirement. 
The SEC does not have data for the prohibition of acceleration of 
payments at subsidiaries of Level 1 or Level 2 parents, and thus cannot 
quantify the impact of the rule on those institutions. The SEC requests 
comment on the effects of the prohibition on acceleration of payments 
may have on compliance costs for BDs and IAs.
9. Relative Performance Measures
    The proposed rule would prohibit the sole use of relative 
performance measures in incentive-based compensation arrangements at 
Level 1 and Level 2 covered institutions. Although relative performance 
measures are widely used to filter out uncontrollable events that are 
outside of management control and can reduce the efficiency of the 
compensation arrangement, a peer group could be opportunistically 
selected to justify compensation awards at a covered institution. To 
the extent that covered persons may influence peer selection, 
opportunism in choosing a performance benchmark may translate into 
covered persons selectively choosing benchmark firms in order to 
increase or justify increases in their compensation awards.
    Evidence on whether such practices take place is mixed. For 
example, one study examined the selection of peer firms used as 
benchmarks in setting compensation for a wide range of firms and showed 
that, on average, chosen peer firms provided higher levels of 
compensation to their executives. The study asserts that managers tend 
to choose higher paying firms as peers to justify increases in the 
level of their own compensation.\445\ The same study also found that 
the choice of highly paid peers is more prevalent when the CEO is also 
the chair of the board of directors, re-enforcing the argument for 
opportunism in peer selection. Another study found that executives 
attempt to justify increases in their compensation by choosing 
relatively larger firms as their peers since larger firms are likely to 
offer higher compensation to their executives.\446\ However, the study 
also showed that boards of directors exercise conservative discretion 
in using information from benchmark firms when setting compensation 
practices. Finally, a third related study \447\ suggests that firms 
choose peers with (relatively) highly paid CEOs when their own CEO is 
highly talented, a finding that is not consistent with opportunism 
regarding the choice of peers in compensation setting. Overall, 
empirical studies suggest that opportunism in the peer group selection 
may exist, particularly in companies where the CEO may exert influence 
over her compensation setting process. By restricting the sole use of 
relative performance measures in compensation arrangements, the 
proposed rule would curb the ability of covered persons to engage in 
such opportunistic behavior, which would benefit covered BDs and IAs.
---------------------------------------------------------------------------

    \445\ See Faulkender, M., Yang, J. 2010. Inside the black box: 
The role and composition of compensation peer groups. Journal of 
Financial Economics 96, 257-270. The study suggests that companies 
appear to select highly paid peers as a benchmark for their CEO's 
pay to justify higher CEO compensation. The study also suggests that 
such an effect is stronger when governance is weaker: In companies 
where the CEO is also the chairman of the board, has longer tenure, 
and when directors are busier serving on multiple boards.
    \446\ See Bizjak, J., Lemmon, M., Nguyen, T. 2011. Are all CEOs 
above average? An empirical analysis of compensation peer groups and 
pay design. Journal of Financial Economics 100, 538-555. The study 
suggests that companies use compensation peer groups that are larger 
or provide higher pay in order to inflate pay in their own company 
and this practice is more prevalent for companies outside of the 
S&P500. However, the study also shows that boards exercise 
discretion in adjusting compensation due to the peer group effect; 
pay increases only close about one-third of the gap between company 
CEO and peer group CEO pay.
    \447\ See Albuquerque, A., De Franco, G., Verdi, R. 2013. Peer 
Choice in CEO Compensation. Journal of Financial Economics 108, 160-
181. The study examines whether companies that benchmark CEO pay 
against highly paid peer CEOs is driven by incentives to increase 
CEO pay. Whereas the study suggests that benchmarking pay against 
highly paid peer CEOs is driven by opportunism, such practice mostly 
represents increased compensation for CEO talent.
---------------------------------------------------------------------------

    As mentioned above, the proposed rule would prohibit the sole use 
of relative performance measures in determining compensation at covered 
institutions. Constraining the use of relative performance measures in 
incentive-based compensation contracts has potential costs. Absolute 
firm performance is typically driven by multiple factors and not all of 
these factors are under the covered persons' control. If incentive-
based compensation is tied to measures of absolute firm performance, 
then at least

[[Page 37794]]

a part of incentive-based compensation will be tied to events out of 
covered persons' control. This could generate uncertainty about 
compensation outcomes for covered persons, reducing the efficiency of 
the incentive-based compensation arrangement. Whereas the proposed rule 
would not prohibit the use of relative performance measures, if the 
proposed limitation regarding the use of performance measures in 
determining compensation awards leads to less filtering out of the 
uncontrollable risk component of performance, then covered institutions 
may increase overall pay to compensate covered persons for bearing 
uncontrollable risk.
    The SEC's baseline analysis of current compensation practices 
suggests that most Level 1 and Level 2 covered institutions use a mix 
of absolute and relative performance measures. If BDs and IAs have 
similar policies as their parent institutions, and the compensation 
structure of private institutions is similar to that of public 
institutions, the SEC does not expect this rule requirement to generate 
significant compliance costs for covered institutions. The cost of 
compliance with the proposed rule would mostly affect the few BDs and 
IAs whose parent institutions do not currently implement such a 
requirement. On the other hand, if the compensation practices of parent 
institutions are significantly different than those at their 
subsidiaries (e.g., they do not use absolute performance measures, or 
use mostly absolute measures), covered BDs and IAs could experience 
significant compliance costs when implementing the proposed rule. Since 
the SEC does not have data on how many covered IAs have parent 
institutions, it is also possible that a significant number of these 
IAs may be stand-alone companies and therefore could have higher costs 
to comply with this specific requirement of the proposed rule compared 
to covered IAs and BDs that are part of reporting parent institutions. 
The same holds true if the compensation of BDs and IAs is generally 
different than that of banking institutions, which most of their parent 
institutions are.
    The SEC has attempted to quantify such costs based on the estimates 
in Table 14. The SEC also notes that these costs are not necessarily 
going to be in addition to the compliance costs discussed above, as 
covered institutions may hire a compensation consultant to help them 
with several requirements in the proposed rules. These costs could be 
lower, however, if the parent institutions of BDs and IAs already 
employ compensation consultants and could extend their services to meet 
the proposed rule requirements for BDs and IAs. Lastly, because some 
BDs and IAs are subsidiaries of private parent institutions, if there 
is a significant difference in the compensation practices of public and 
private covered institutions such BDs and IAs could face large 
compliance costs. The SEC does not have data for the prohibition of the 
sole use of relative performance measures at subsidiaries of Level 1 or 
Level 2 parents, and thus cannot quantify the impact of the rule on 
those institutions. To better assess the effects of this prohibition on 
compliance costs for BDs and IAs. The SEC requests detailed comments 
below.
10. Volume-Driven Incentive-Based Compensation
    For covered persons at Level 1 and Level 2 covered institutions, 
the proposed rule would prohibit incentive-based compensation 
arrangements that are based solely on the volume of transactions being 
generated without regard to transaction quality or compliance of the 
covered person with sound risk management. Such a compensation contract 
would provide incentives for employees to maximize the number of 
transactions since that outcome would lead to maximizing their 
compensation. A compensation contract that solely uses volume as the 
performance indicator is likely to provide employees with incentives 
for inappropriate risk-taking since employees benefit from one aspect 
of performance but do not bear the negative consequences of their 
actions--the associated costs and risks incurred to generate revenue/
volume. There is limited academic literature addressing the effect of 
volume-driven compensation on employee incentives. A study examined the 
behavior of loan officers at a major commercial bank when compensation 
switched from a fixed salary structure to a performance-based structure 
where the measure of performance was set as loan origination 
volume.\448\ The study found a 31 percent increase in loan approvals, 
holding other factors related to the probability of loan approvals 
constant. The study also found that the 12-month probability of default 
in originating loans increased by 27.9 percent. Whereas the study did 
not conclude whether the bank was better or worse off due to the 
introduction of the compensation scheme, the authors found that 
interest rates charged to lower quality loans did not reflect the 
increased riskiness of the borrowers. Another related study \449\ finds 
that loan officers who are incentivized based on lending volume rather 
than on the quality of their loan portfolio originate more loans of 
lower average quality. The study also finds that due to the presence of 
career concerns or reputational motivations, loan officers with lending 
volume incentives do not indiscriminately approve all applications. 
Whereas the study examines the effects of volume-driven compensation on 
employees that are not likely to be covered by the proposed rule, it 
confirms intuition that providing incentives for volume maximization 
may lead to behaviors that do not necessarily maximize firm value.
---------------------------------------------------------------------------

    \448\ See Agarwal, S., Ben-David, I. 2014. Do Loan Officers' 
Incentives Lead to Lax Lending Standards? NBER Working Paper. This 
study examines changes in lending practices in one of the largest 
U.S. commercial banks when loan officers' compensation structure was 
altered from fixed salary to volume-based pay. The study suggests 
that following the change in the compensation structure, loan 
origination became more aggressive as evident by higher origination 
rates, larger loan sizes, and higher default rates. The study 
estimates that 10% of the loans under the volume-based compensation 
structure were likely to have negative net present value.
    \449\ See Cole, S., Kanz, M., Klapper, L. 2015. Incentivizing 
Calculated Risk-Taking: Evidence from an Experiment with Commercial 
Bank Loan Officers. Journal of Finance 70, 537-575. The study 
examines the effect of different incentive-based compensation 
arrangements on loan originators behavior in screening and approving 
loans in an Indian commercial bank. In general, the study finds that 
the structure of incentive-based arrangements for loan officers 
affects their decisions; the performance metric used in compensation 
arrangements of loan officers as well as whether pay is deferred 
affect loan officers screening and approval incentives and 
corresponding decisions.
---------------------------------------------------------------------------

    It is unclear to the SEC whether volume-driven incentive-based 
compensation arrangements are utilized by IAs and BDs given the nature 
of the business conducted by IAs and BDs. Assuming that these 
incentive-based compensation arrangements are relevant to IAs and BDs, 
restricting the sole use of volume-driven compensation practices may 
curb incentives that reward employees of BDs and IAs on only partial 
outcomes of their actions; partial in the sense that costs and risks 
associated with those actions are not part of the performance 
indicators used to determine their compensation. As a consequence, to 
the extent that BDs and IAs contribute significantly to the overall 
risk profile of their parent institutions, covered persons' incentives 
would likely become aligned with the interests of stakeholders, 
including taxpayers, since covered persons would bear both the benefits 
and the costs from their actions. Likewise, the prohibition on the sole 
use of volume-driven compensation practices is also likely to

[[Page 37795]]

limit covered persons' incentives for inappropriate risk-taking.
    The effect of this proposed rule on BDs and IAs cannot be 
unambiguously determined because of the lack of data on the current use 
of volume-driven compensation practices. If BDs and IAs have already 
instituted similar policies with respect to senior executive officers 
and significant risk-takers, the SEC does not expect this rule 
requirement to generate significant compliance costs for covered 
institutions. On the other hand, if covered BDs and IAs' compensation 
practices with respect to senior executive officers and significant 
risk-takers rely exclusively on volume-driven transactions, covered BDs 
and IAs could experience significant compliance costs when implementing 
the proposed rule. To better assess the effects of this prohibition on 
compliance costs for BDs and IAs the SEC requests comments below.
11. Risk Management
    The proposed rule would include specific requirements with regard 
to risk management functions to qualify a covered person's incentive-
based compensation arrangement at Level 1 and Level 2 covered 
institutions as compatible with the rule. Specifically, the proposed 
rule would require that a Level 1 or Level 2 covered institution have a 
risk management framework for its incentive-based compensation 
arrangement that is independent of any lines of business, includes an 
independent compliance program that provides for internal controls, 
testing, monitoring, and training, with written policies and procedures 
consistent with the proposed rules, and is commensurate with the size 
and complexity of a covered institution's operations. Moreover, the 
proposed rule would require that covered persons engaged in control 
functions be provided with the authority to influence the risk-taking 
of the business areas they monitor and be compensated in accordance 
with the achievement of performance objectives linked to their control 
functions and independent of the performance of the business areas they 
monitor. Finally, a Level 1 or Level 2 covered institution would be 
required to provide independent monitoring of all incentive-based 
compensation plans, events related to forfeiture and downward 
adjustment and decisions of forfeiture and downward adjustment reviews, 
and compliance of the incentive-based compensation program with the 
covered institution's policies and procedures.
    The proposed requirements may strengthen the risk management and 
control functions of covered BDs and IAs, which could result in lower 
levels of inappropriate risk-taking. Academic literature suggests that 
stronger risk controls in bank holding companies resulted in lower risk 
exposure, as evident by lower tail-risk and lower fraction of non-
performing loans; and better performance, as evident by better 
operating performance and stock return performance, during the 
crisis.\450\ This study also shows that the risk management function is 
stronger for larger banks, banks with larger derivative trading 
operations and banks whose CEOs compensation is more closely tied to 
stock volatility. Additionally, the study shows that stronger risk 
function, as measured by this study, was associated with better firm 
performance only during crisis years, whereas the same relation did not 
hold during non-crisis periods. As such, a strong and independent risk 
management function can curtail tail risk exposures at banks and 
potentially enhance value, particularly during crisis years. Another 
study shows that lenders with a relatively powerful risk manager, as 
measured by the level of the risk manager's compensation relative to 
the top named executives' level of compensation, experienced lower loan 
default rates. Thus, the evidence in the study seems to suggest that 
powerful risk executives curb risk-taking with respect to loan 
origination.\451\
---------------------------------------------------------------------------

    \450\ See Ellul, A., Yerramilli, V. 2013. Stronger Risk 
Controls, Lower Risk: Evidence from U.S. Bank Holding Companies. 
Journal of Finance 68, 1757-1803.
    \451\ See Keys, B., Mukherjee, T., Seru, A., Vig, Vikrant. 2009. 
Financial regulation and securitization: Evidence from subprime 
loans. Journal of Monetary Economics 56, 700-720.
---------------------------------------------------------------------------

    It is also possible that the proposed requirements may not have an 
effect on the current level of risk-taking at BDs and IAs. For example, 
if risk-taking is driven by the culture of the institution, then 
governance characteristics (including risk management functions) may 
reflect the choice of control functions that match the inherent risk-
taking appetite in the institution.\452\ A potential downside of 
applying a strict risk management control function over covered BDs and 
IAs is that it could lead to decreased risk-taking and potential loss 
of value for those BDs and IAs that already employ an optimal risk 
management function. For such BDs and IAs, the implementation of the 
rule requirements with respect to risk management could result in lower 
than optimal risk-taking by covered persons.
---------------------------------------------------------------------------

    \452\ See Cheng, I., Hong, H., Scheinkman, J. 2015. Yesterday's 
Heroes: Compensation and Risk at Financial Firms. Journal of Finance 
70, 839-879.
---------------------------------------------------------------------------

    Based on the SEC's baseline analysis, it appears that all Level 1 
parent institutions and most Level 2 parent institutions (67 percent) 
of BDs already have an independent risk management and control function 
(e.g., a risk committee) and compensation monitoring function (e.g., a 
fully independent compensation committee) \453\ that could apply the 
rule requirements. Similarly, all of the Level 1 and Level 2 parent 
institutions of IAs have risk committees and substantial portion (80 
percent and above) have fully independent compensation committees. The 
SEC, however, does not have information on whether risk committees 
review and monitor the incentive-based compensation plans. The SEC's 
analysis suggests that there are some Level 1 covered institutions (30 
percent) and Level 2 covered institutions (20 percent) where CROs 
review compensation packages.
---------------------------------------------------------------------------

    \453\ A risk committee is ``fully independent'' for purposes of 
this discussion if it consists only of directors that are not 
employees of the corporation.
---------------------------------------------------------------------------

    If BDs and IAs have similar policies as their parent institutions, 
and the risk management structure of private institutions is similar to 
that of public institutions, the implementation of the proposed rule in 
its part related to risk management and control is unlikely to lead to 
significant compliance costs for the majority of covered BDs and IAs 
because, as mentioned in the previous paragraph, a large percentage of 
the parent institutions already have fully independent risk committees. 
Some BDs with Level 2 parent institutions and some IAs with Level 1 and 
Level 2 parent institutions may face high compliance costs because 
their parent institutions currently do not employ risk management and 
compensation monitoring practices similar to the one prescribed by the 
proposed rule. On the other hand, if the risk management practices of 
parent institutions are significantly different from those at their 
subsidiaries (e.g., BDs and IAs do not have risk management and control 
functions), covered BDs and IAs could experience significant compliance 
costs when implementing the proposed rule. Since the SEC does not have 
data on how many covered IAs have parent institutions, it is also 
possible that a significant number of these IAs may be stand-alone 
companies and therefore could have higher costs to comply with this 
specific requirement of the proposed rule compared to covered IAs and 
BDs that are part of reporting parent institutions. BDs and IAs could 
also incur direct economic costs such as decrease in firm value if the 
proposed

[[Page 37796]]

rule requirements regarding risk management lead to less risk-taking 
than is optimal. The same holds true if the risk management and 
controls of BDs and IAs is generally different than that of banking 
institutions, which most of their parent institutions are.
    Lastly, because some BDs and IAs are subsidiaries of private parent 
institutions, if there is a significant difference in the risk 
management practices of public and private covered institutions such 
BDs and IAs could face large compliance costs and direct economic 
costs. The SEC does not have data for the risk management and control 
functions at subsidiaries of Level 1 or Level 2 parents, and thus 
cannot quantify the impact of the rule on those institutions. To better 
assess the effects of these rule requirements on compliance costs for 
BDs and IAs the SEC requests comments below.
    The SEC has attempted to quantify the potential compliance costs 
for BDs and IAs associated with the proposed rule's requirements 
regarding the existence and structure of compensation committees and 
risk committees. BDs and IAs that are currently not in compliance with 
the proposed committee requirements, either because such a committee 
does not exist or because the composition of such committee is not 
consistent with the rule requirements, may have to elect additional 
individuals in order to either establish the required committees or 
alter the structure of such committees to be in compliance with the 
rule's requirements. Table 15 provides estimates of the average annual 
total compensation of non-employee (i.e. independent) directors for 
Level 1 and Level 2 parents of BDs and Level 1 and Level 2 parents of 
IAs covered by the proposed rule.\454\ Assuming that the cost estimates 
in the table approximate the compensation requirements for independent 
members of compensation and/or risk committees, the incremental 
compliance costs of electing an additional non-employee director to 
comply with this specific provision of the rule for BDs and IAs that 
currently do not meet the rule's requirements could be approximately 
$333,086 and $309,513 annually per independent director for a Level 1 
BDs and IAs, respectively, and approximately $208,009 and $194,563 
annually per independent director for unconsolidated Level 2 BDs and 
IAs, respectively.
---------------------------------------------------------------------------

    \454\ Data is taken from 2015 proxy statements.

 Table 15--Average Total Annual Compensation of a Non-Employee Director
              for Level 1 and Level 2 Covered Institutions
------------------------------------------------------------------------
                                                           Average total
                                                              annual
                                                           compensation
                                                             of a non-
                                                             employee
                                                             director
------------------------------------------------------------------------
BD parents:
  Level 1 covered institutions..........................        $333,086
  Level 2 covered institutions..........................         208,009
IA parents:
  Level 1 covered institutions..........................         309,513
  Level 2 covered institutions..........................         194,563
------------------------------------------------------------------------

    The SEC considers these estimates an upper bound of potential costs 
that BDs and IAs may incur to comply with these requirements of the 
proposed rule. It is possible that some BDs and IAs are able to 
reshuffle existing personnel in order to comply with the rule's 
requirements (e.g., use existing directors to create a risk committee 
or fully independent compensation committee) and as such would not 
incur any of the costs described in the analysis.
12. Governance, Policies and Procedures
    For Level 1 and Level 2 covered institutions, the proposed rule 
would include specific corporate governance requirements to support the 
design and implementation of compensation arrangements that provide 
balanced risk-taking incentives to affected individuals. More 
specifically, the proposed rule would require the existence of a 
compensation committee composed solely of directors who are not senior 
executive officers, input from the corresponding risk and audit 
committees and risk management on the effectiveness of risk measures 
and adjustments used to balance incentive-based compensation 
arrangements, and a written assessment, submitted at least annually to 
the compensation committee from the management of the covered 
institution, regarding the effectiveness of the covered institution's 
incentive-based compensation program and related compliance and control 
processes and an independent written assessment of the effectiveness of 
the covered institution's incentive-based compensation program and 
related compliance and control processes in providing risk-taking 
incentives that are consistent with the risk profile of the covered 
institution, submitted on an annual or more frequent basis by the 
internal audit or risk management function of the covered institution, 
developed independently of the covered institution's management.
    The proposed governance requirements would benefit covered BDs and 
IAs by further ensuring that the design of compensation arrangements is 
independent of the persons receiving compensation under these 
arrangements, thus curbing potential conflicts of interest. It could 
also facilitate the optimal design of compensation arrangements by 
incorporating relevant information from committees whose mandate is 
risk oversight. For example, by having a fully independent compensation 
committee that designs compensation arrangements and a risk committee 
that reviews those compensation arrangements to make sure they are 
consistent with the institution's optimal risk policy, a BD or IA may 
be able to devise compensation arrangements that provide a better link 
between pay and performance for covered persons.
    Based on the SEC's baseline analysis, it appears that the majority 
of Level 1 and Level 2 covered parent institutions already have a fully 
independent compensation committee. The SEC does not have information 
whether BDs and IAs that are subsidiaries have compensation committees 
and boards of directors. In 2012, the SEC adopted rules requiring 
exchanges to adopt listing standards requiring a board compensation 
committee that satisfies independence standards that are more stringent 
than those in the proposed rule.\455\ Therefore, all covered parent 
institutions with listed securities on national exchanges, or any 
covered BDs and IAs with listed securities, should have compensation 
committees that would satisfy the proposed rule's compensation 
committee independence requirements. Thus, this proposed requirement 
should place no additional burden on those IAs and BDs that have listed 
securities on national exchanges, or have governance structures similar 
to those of their listed parent institutions.
---------------------------------------------------------------------------

    \455\ 17 CFR parts 229 and 240.
---------------------------------------------------------------------------

    For those BDs and IAs that have compensation committees, the SEC 
does not have information whether management of the covered BDs and IAs 
submits to the compensation committee on an annual or more frequent 
basis a written assessment of the effectiveness of the covered 
institution's incentive-based compensation program and related 
compliance and control processes in providing risk-taking incentives 
that are consistent with the risk profile of the covered institution.

[[Page 37797]]

Additionally, the SEC does not have information on whether the 
compensation committee obtains input from the covered institution's 
risk and audit committees, or groups performing similar functions. If 
covered BDs and IAs have already instituted similar policies with 
respect to the proposed rule's governanc