Regulatory Agencies Release Final Incentive Compensation Guidelines for Banking Organizations
On June 21, 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 final guidance on sound incentive compensation policies for banking organizations. As outlined in the final guidance, banking organizations must maintain incentive compensation practices that are consistent with safety and
soundness principles, even though this may require more conservative incentive compensation practices than are necessary to align employees' interests with those of shareholders.
The Regulatory Agencies state that incentive compensation arrangements at a banking organization should generally:
- Provide employees incentives that appropriately balance risk and reward;
- 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.
The final guidance states that, because of the size and complexity of their operations, large banking organizations should have and adhere to systematic and formalized policies, procedures, and processes to govern incentive compensation arrangements. Smaller banking organizations are expected to employ less extensive and less formalized policies, procedures and systems than their larger counterparts.
To implement the recommendations contained in the final guidance, the Regulatory Agencies will analyze incentive compensation practices at large, complex banking organizations, building on similar reviews of incentive compensation practices at large banking organizations that have been conducted by the Federal Reserve over the past year. The Regulatory Agencies will also integrate the final guidance into the regulatory examination process of smaller banking organizations. During examinations, the Regulatory Agencies will review incentive compensation arrangements at smaller banking organizations for consistency with the safety and soundness of the banking organization while evaluating those organizations’ risk-management, internal controls and corporate governance.
Impact on Smaller Banking Organizations and Community Banks. The Regulatory Agencies will tailor the evaluation of incentive compensation arrangements implemented by smaller banking organizations, and whether these arrangements appropriately account for risk to the banking organization, to the organization's size, complexity, business lines and risk tolerance. Smaller banking organizations and community banks should be particularly aware of the following portions of the final guidance:
- During examinations, the Regulatory Agencies will evaluate whether the banking organization has incorporated the recommendations contained in the final guidance into its incentive compensation practices.
- Banking organizations should develop risk-management processes and internal controls to support the development and maintenance of balanced incentive compensation arrangements.
- Risk-management personnel should be involved in designing incentive compensation arrangements and assessing the arrangements' effectiveness in restraining imprudent risk taking.
- Banking organizations should continuously monitor incentive compensation arrangements, particularly incentive compensation awards and actual risk outcomes, to determine whether these awards appropriately reflect the associated risk to the organization.
- The board of directors should actively oversee incentive compensation arrangements, evaluate whether these arrangements jeopardize the banking organization's safety and soundness and regularly review the design and function of incentive compensation arrangements.
- Directors of banking organizations should possess or have access to expertise in risk-management and incentive compensation practices in the financial services industry that is appropriate in light of the risks faced by the banking organization.
- A banking organization's federal supervisor may initiate enforcement action if the organization's incentive compensation arrangements (or related risk- management, control or governance processes) pose a risk to the safety and soundness of the organization.
If you have any questions regarding these matters, please contact the lawyers listed above or your regular Troutman Sanders contact.
The foregoing is only a summary of one of the many significant issues affecting bank holding companies and banking organizations. 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.