Better Markets filed a comment letter with the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation, the National Credit Union Administration, and the Federal Housing Finance Agency on the latest proposed rulemaking for incentive-based compensation

Why It Matters. Financial executives and traders regularly pocket million-dollar bonuses. The prospect of unimaginable and immediate riches, however, often results in those executives and traders taking excessive and unjustified risks. The executives and traders benefit from immense upside when they win, while individual financial institutions, the financial system, and Main Street Americans are exposed to downside risk and enormous financial losses when they lose.

What We Said. While we are encouraged by the proposed rule from regulators to address these issues, the proposal is long overdue, needs improvement, and requires the buy-in of the SEC (Securities and Exchange Commission) and Federal Reserve (Fed).

Section 956 of the Dodd-Frank Act directed financial regulators to remedy the unjust and unfair imbalance of incentives with a set of new rules for financial institutions and executives to follow related to incentive-based compensation. The Dodd-Frank Act was passed on July 10, 2010, and the new rules were due within 9 months of that date. Unfortunately, more than 14 years have passed since the enactment of the Dodd-Frank Act, and after two failed rulemaking attempts in 2011 and 2016, there is still no incentive-based compensation rule.

The Dodd-Frank Act also required that financial regulators work together to pass a set of joint rules. This is important for fair and consistent treatment throughout the financial system. However, the Federal Reserve (Fed) and the Securities and Exchange Commission (SEC) have not joined in this rulemaking effort and failing to meet their statutory responsibilities, as well as their duty to act in the best interest of the American people. Fed Chair Jerome Powell has given myriad excuses for the Fed’s decision to not participate in the rulemaking, ranging from the fact that he does not think new rules are needed to the fact that there is existing, albeit outdated and weak, incentive-based compensation guidance from 2010. The SEC has not explained its decision to not participate in this rulemaking. Regardless of the reasons, the bottom line is that the financial regulators must act in the interest of the American people and finalize incentive-based compensation regulations.

Bottom Line. If all the financial regulators can get on the same page, we are encouraged by the content of the proposed rule. It broadens the scope of the new rule beyond just senior executive officers to include other significant risk-takers who could put financial institutions and the public at risk of loss, it adds a clawback provision to recover incentive-based compensation under certain circumstances, and it prohibits hedging by institutions to protect employees and executives against decreases in the value of incentive-based compensation. However, the proposed rule still suffers from multiple flaws and gaps, which should be fixed before finalization:

• Clawbacks: The type of conduct that triggers clawbacks should be expanded beyond culpable behavior. In addition, covered institutions should be required to exercise their clawback remedies, not simply be allowed to do so.
• Vesting Periods: The deferral periods should be extended, and pro rata vesting should be abandoned in favor of cliff vesting.
• Stock Options: Stock options should be banned as a form of incentive-based compensation, including as a form of deferred incentive-based compensation.
• Hedging: The prohibition on hedging should cover individuals, not only the institutions acting on their behalf.