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It boggles my mind that, almost fourteen years after the Dodd-Frank Act was enacted, we still have unfinished rulemaking directives from that legislation. For those of you who may not have been practicing fourteen years ago, the enactment of Dodd-Frank was a big deal, because at the time we were still very much hurting from an extraordinary financial crisis for which there had been little accountability. Unfortunately, instead of accountability, we got some real gems of new disclosure rules out of the Dodd-Frank Act, such as pay versus performance, CEO pay ratio, conflict minerals and resource extraction payments. But one piece of Dodd-Frank actually sought accountability through rigid limitations on incentive compensation at financial institutions, and that is the rulemaking that remains unfinished to this day.

As Meredith noted last week on The Advisors’ Blog on CompensationStandards.com, some of the financial institutions tasked with writing the incentive compensation rules recently took action to re-propose the rules, which were last proposed in June 2016. Last week, the FDIC, the Office of the Comptroller of the Currency, and the Federal Housing Finance Agency adopted a Notice of Proposed Rulemaking to address incentive-based compensation arrangements, as required under Section 956 of the Dodd-Frank Act. The National Credit Union Administration is expected to take action on the proposed rules in the near future, and the SEC has included a rulemaking to implement Section 956 on its rulemaking agenda. The Board of Governors of the Federal Reserve did not join the joint proposal of the banking regulators, with Chair Powell recently testifying: “I would like to understand the problem we’re solving, and then I would like to see a proposal that addresses that problem.”

As this Sullivan & Cromwell memo notes, the proposed rules is consistent with the 2016 proposed rule and includes the following key provisions:

– Approach to Proportionality. Covered institutions are categorized into three tiers based on average total consolidated assets, with increasingly stringent requirements applying to institutions with over $1 billion, $50 billion and $250 billion in assets (Level 3, Level 2 and Level 1 covered institutions, respectively).

– Defining Covered Persons. Additional, more stringent rules apply to incentive-based compensation paid to “senior executive officers” and “significant risk-takers” at Level 1 and Level 2 covered institutions. The proposed rule provides a list of roles that would be classified as senior executive officers and identifies significant risk-takers based on relative compensation levels or ability to commit or expose 0.5% of the covered institution’s capital.

– Limits on Incentive Opportunity & Structures. At Level 1 and Level 2 covered institutions, the maximum earned incentive for senior executive officers is limited to 125% of the target amount, and for significant risk-takers is limited to 150% of target. (There are no fixed limits on the absolute size of potential targets.) General requirements for performance determinations would apply to all covered institutions, and Level 1 and Level 2 covered institutions would face prohibitions on the use of relative or volume-driven performance measures in isolation.

– Mandatory Deferral Requirements. The proposed rule introduces longer deferral periods (up to four years after the end of the performance period) and higher minimum deferral amounts (up to 60%) for incentive-based compensation depending on whether the covered institution is Level 1 or Level 2 and whether the individual is a senior executive officer or significant risk-taker. Deferred incentive-based compensation generally may not vest faster than on a pro rata annual basis beginning on the first anniversary of the end of the performance period and must include a “substantial portion” of both equity-like instruments and deferred cash.

– Putting and Keeping Pay at Risk. All incentive-based compensation for senior executive officers and significant risk-takers at Level 1 and Level 2 covered institutions must be subject to downward adjustment, forfeiture and clawback. The proposed rule includes a list of triggering events that require a downward adjustment and forfeiture review at Level 1 and Level 2 covered institutions. In addition, it would subject incentive pay to clawback for seven years after compensation vests.

– Governance, Risk Management and Recordkeeping Requirements. New requirements would apply to board of director and compensation committee oversight and approvals. Covered institutions would be subject to annual recordkeeping and seven-year retention requirements, with records disclosed to the appropriate Agency on request. The proposed rule also contains specific risk management and control requirements.

In my view, Section 956 of the Dodd-Frank Act was flawed from the start, making this rulemaking effort particularly challenging for the financial regulators. The reactionary approach taken by Congress in Section 956 was perhaps somewhat understandable in the wake of the financial crisis, but now seems overboard given that we are over a decade and a half removed from that particular situation. Unfortunately, the financial institutions regulators are stuck with the statutory directive, making it difficult for them to adopt rules that are more reflective of where we stand today.

– Dave Lynn