March 15, 2023

The Dodd-Frank Act Stragglers

With all of the focus these past few days on upheaval in the banking industry, including discussion of the compensation paid to executives of troubled financial institutions, I was reminded of the rulemaking initiatives that remain undone on the Dodd-Frank Act To-Do List, over a dozen years after that landmark legislation sought to right the wrongs after the financial crisis. As we grapple with the pay versus performance disclosure and clawback requirements that were just adopted last year, it is easy to forget one remaining compensation and governance rulemaking on the agenda for the SEC and other financial regulators.

Section 956 of the Dodd-Frank Act directs the financial institutions regulators to jointly prescribe regulations or guidelines with respect to incentive-based compensation practices at certain covered financial institutions. Specifically, Section 956 requires that the regulators prohibit any types of incentive-based compensation arrangements, or any feature of any such arrangements, that the regulators 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 Section 956, a covered financial institution also must disclose to its appropriate 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 defines “covered financial institution” to include specific types of financial institutions that have $1 billion or more in assets.

The SEC and the other financial regulators were quick out of the gate with a proposal to implement Section 956. In March 2011, the SEC and six other regulators that included the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, the Federal Housing Finance Agency, the National Credit Union Administration, the Office of the Comptroller of the Currency and the Office of Thrift Supervision jointly published proposed rules with a 45-day comment period. A little over five years later, in May 2016, the regulators tried again, publishing new joint proposed rules to implement Section 956. In the proposing release, the regulators noted:

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, FHFA has gained supervisory experience in applying compensation-related rules adopted under the authority of the Safety and Soundness Act, and foreign jurisdictions have adopted incentive-based compensation remuneration codes, regulations, and guidance. 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.

After the 2016 re-proposal, we haven’t heard anything more from the regulators about implementing Section 956. As this Thomson Reuters article from last summer notes, the proposed rules faced some considerable opposition from the financial services industry, and while various attempts have been made to move the rulemaking forward, it remains in a sort of regulatory limbo. The fact that this provision of the Dodd-Frank Act requires joint agency action may account for some of the delay, but it is curious that the rulemaking has been stalled for so long. Perhaps the recent reminder of what it is like to have major bank failures will renew the focus on this piece of unfinished business.

– Dave Lynn