Alert January 19, 2010

FDIC’s Board Approves Issuance of ANPR Seeking Public Comment on Whether to Incorporate Risks Related to Compensation Programs into Risk-Based Deposit Insurance Assessment System

The FDIC’s Board of Directors, by a 3-to-2 vote, approved the issuance of an advance notice of proposed rulemaking (“ANPR”) concerning whether an insured depository institution (“IDI”) compensation program should be incorporated as a factor into the FDIC’s determination of the risk-based deposit insurance premium to be charged to the IDI. The FDIC requested public comment on the ANPR and posed 15 specific questions for comment that are noted below. Under Section 7 of the Federal Deposit Insurance Act, the FDIC is supposed to establish a risk-based assessment system for IDIs that incorporates the factors the FDIC believes are relevant in assessing the probability that the Deposit Insurance Fund (“DIF”) will incur a loss because of an IDI. The FDIC states in the ANPR that it has concluded that IDI compensation practices led to excessive risk-taking by IDI management that contributed to the recent financial crisis.

The FDIC stresses in the ANPR that it does not seek to limit compensation of IDIs, but rather it seeks to adjust risk-based deposit insurance assessment rates to adequately compensate the DIF “for the risks inherent in the design of certain compensation programs.” The FDIC says that it seeks to provide incentives for IDIs and their holding companies to adopt compensation programs that “align employees’ interests with the long‑term interests” of the IDI, the FDIC and the IDI’s other stockholders. The FDIC also wants to promote the use of compensation programs that reward employees for focusing on risk management. The FDIC does not propose specific minimum compensation standards in the ANPR.

The FDIC proposes in the ANPR that IDIs that incorporate three specific criteria into their compensation programs, benefit by being charged lower risk-assessment deposit premiums. The three criteria are:

  1. an employee whose business activities present a significant risk to the IDI should have a significant component of his or her compensation paid in restricted non‑discounted IDI stock;
  2. significant awards in IDI stock should only vest over a multi-year period, with the possibility of a clawback, or other look-back mechanism; and
  3. employee compensation programs should be administered by an independent committee of the Board of Directors (with input from independent compensation professionals).

The FDIC requested public comment on all aspects of the ANPR, but in particular requested comments on the following 15 questions:

“1. Should an adjustment be made to the risk-based assessment rate an institution would otherwise be charged if the institution could/could not attest (subject to verification) that it had a compensation system that included the following elements?

a. A significant portion of compensation for employees whose business activities can present significant risk to the institution and who also receive a portion of their compensation according to formulas based on meeting performance goals would be comprised of restricted, non-discounted company stock. The employees affected would include the institution’s senior management, among others. Restricted, non-discounted company stock would be stock that becomes available to the employee at intervals over a period of years. Additionally, the stock would initially be awarded at the closing price in effect on the day of the award.

b. Significant awards of company stock would only become vested over a multi-year period and would be subject to a look-back mechanism (e.g., clawback) designed to account for the outcome of risks assumed in earlier periods.

c. The compensation program would be administered by a committee of the board composed of independent directors with input from independent compensation professionals.

2. Should the FDIC’s risk-based assessment system reward firms whose compensation programs present lower risk or penalize institutions with programs that present higher risks?

3. How should the FDIC measure and assess whether an institution’s board of directors is effectively overseeing the design and implementation of the institution’s compensation program?

4. As an alternative to the FDIC’s contemplated approach (see q. 1), should the FDIC consider the use of quantifiable measures of compensation—such as ratios of compensation to some specified variable—that relate to the institution’s health or performance? If so, what measure(s) and what variables would be appropriate?

5. Should the effort to price the risk posed to the DIF by certain compensation plans be directed only toward larger institutions; institutions that engage only in certain types of activities, such as trading; or should it include all insured depository institutions?

6. How large (that is, how many basis points) would an adjustment to the initial risk‑based assessment rate of an institution need to be in order for the FDIC to have an effective influence on compensation practices?

7. Should the criteria used to adjust the FDIC’s risk-based assessment rates apply only to the compensation systems of insured depository institutions? Under what circumstances should the criteria also consider the compensation programs of holding companies and affiliates?

8. How should the FDIC’s risk-based assessment system be adjusted when an employee is paid by both the insured depository institution and its related holding company or affiliate?

9. Which employees should be subject to the compensation criteria that would be used to adjust the FDIC’s risk-based assessment rates? For example, should the compensation criteria be applicable only to executives and those employees who are in a position to place the institution at significant risk? If the criteria should only be applied to certain employees, how would one identify these employees?

10. How should compensation be defined?

11. What mix of current compensation and deferred compensation would best align the interests of employees with the long-term risk of the firm?

12. Employee compensation programs commonly provide for bonus compensation. Should an adjustment be made to risk-based assessment rates if certain bonus compensation practices are followed, such as: awarding guaranteed bonuses; granting bonuses that are greatly disproportionate to regular salary; or paying bonuses all-at-once, which does not allow for deferral or any later modification?

13. For the purpose of aligning an employee’s interests with those of the institution, what would be a reasonable period for deferral of the payment of variable or bonus compensation? Is the appropriate deferral period a function of the amount of the award or of the employee’s position within the institution (that is, large bonus awards or awards for more senior employees would be subject to greater deferral)?

14. What would be a reasonable vesting period for deferred compensation?

15. Are there other types of executive compensation arrangements that would have a greater potential to align the incentives of employees with those of the firm’s other stakeholders, including the FDIC?"

Comptroller of the Currency, John Dugan, who voted against approval of the ANPR, issued a statement explaining that he opposed the issuance of the ANPR for two principal reasons. First, said Comptroller Dugan, the issuance of the ANPR is premature because Congress is considering legislation and the FRB has developed supervisory guidance that would cover parent holding companies of IDIs and “it could be very unfortunate to have an end result where [IDIs] – and perhaps their holding companies – were subject to inconsistent compensation” program requirements. Second, Comptroller Dugan stated that he was unconvinced that IDIs’ compensation programs were a risk factor related to the “probability that the [DIF] will incur a loss.”

The FDIC made it clear in the ANPR that it intends its assessment premium revision to be complementary to supervisory actions taken by the FRB and supervisory standards set by other regulators. Comments on the ANPR are due to the FDIC on or before February 18, 2010.