Federal Bank Regulators Increase Exam Focus on Executive and Incentive Compensation
Federal banking regulators have increased their focus on executive and incentive compensation in regulatory examinations, making this area one of the highest priorities in the examination process.
In June 2010 the Board of Governors of the Federal Reserve System, the Office of the Comptroller of the Currency, the Office of Thrift Supervision and the Federal Deposit Insurance Corporation (together, the Regulatory Agencies) issued guidance on sound incentive compensation policies for banking organizations. This guidance states that compensation arrangements at banking organizations should provide employees incentives that appropriately balance risk and reward (so as to not encourage imprudent risk-taking), be compatible with effective controls and risk-management, and be supported by strong corporate governance, including active and effective oversight of incentive compensation arrangements by the board of directors(1). The Regulatory Agencies expect banking organizations to take prompt action to address the principles set forth in its guidance. They may take enforcement action against any banking organization with relevant arrangements that are not compliant with the guidance.
Banking organizations that are publicly traded (or their publicly-traded holding companies, as applicable) also must increase executive compensation disclosures in proxy statements and annual reports once the disclosure requirements contained in the Dodd-Frank Wall Street Reform and Customer Protection Act (the Dodd-Frank Act) are effective. In late 2010, the Securities and Exchange Commission (the SEC) plans to propose rules giving shareholders an advisory vote on executive compensation and so-called golden parachutes. In mid-2011, the SEC plans to propose rules requiring disclosure of the relationship between the executive compensation actually paid and the company’s financial performance, and the ratio of CEO compensation to median employee compensation.
Organizations that focus on corporate governance continue to issue updates to their proxy voting policies, which become more and more influential and must be considered when evaluating compensation practices. Public companies will need to adopt policies that will recapture certain incentive compensation paid to employees. Banking organizations will need to evaluate their relationships with compensation consultants for potential independence and conflict issues. Even pension funding relief, as enacted under the Preservation of Access to Care for Medicare Beneficiaries and Pension Relief Act, will be affected by the amount of compensation paid to employees.
Another potential area of regulatory focus is compliance with Internal Revenue Code (Code) Section 409A, which governs all types of nonqualified deferred compensation. By December 31, 2008, banking organizations should have reviewed and amended, if needed, all nonqualified deferred compensation arrangements (including all deferred compensation plans, employment agreements, severance and change in control agreements, equity compensation plans and similar types of arrangements) to ensure either compliance with Code Section 409A or an exemption from Code Section 409A. For those who missed the deadline, the IRS has established a correction program for arrangements that do not satisfy the document requirements of Code Section 409A. One of the most favorable provisions of the correction program is the ability to correct document failures by December 31, 2010 and avoid the unfavorable tax consequences that typically apply upon noncompliance with Code Section 409A.
In light of these developments, we recommend that banking organizations review their executive compensation agreements and incentive compensation plans and policies as well as their corporate governance and SEC compliance procedures during the 4th quarter of 2010. Such a review will prepare the banking organization for upcoming regulatory examinations, will identify compensation issues for action by the bank or the bank’s board of directors, and will better position the bank or bank holding company to respond to the shareholder vote on executive compensation requirement, the executive compensation disclosure requirements, and any other requirements contained in the Dodd-Frank Act. Moreover, this is one last chance to correct Code Section 409A problems at relatively little cost.
We will continue to monitor how the Regulatory Agencies incorporate reviews of executive and incentive compensation into bank regulatory examinations, and how the SEC implements the Dodd-Frank Act’s executive compensation disclosure requirements. We will provide our friends and clients with future updates regarding these important and timely issues.
The foregoing is only a summary of certain of the many significant issues affecting financial institutions. If you have any questions about the foregoing or about other financial institution issues, please direct them to your regular contact at Troutman Sanders LLP or to any of the persons listed in the sidebar to this release.
(1) For a summary of this guidance, please see our advisory titled “Regulatory Agencies Release Final Incentive Compensation Guidelines for Banking Organizations,” available here. For the full text of this guidance, please see the Regulatory Agencies’ “Guidance on Sound Incentive Compensation Policies,” available here.