Alert June 29, 2010

FRB Issues Final Guidance on Sound Incentive Compensation Practices

The FRB issued final guidance relating to the incentive compensation policies and practices of banking organizations under the FRB’s supervision.  The guidance applies to all banking organizations supervised by the FRB, the Office of the Comptroller of the Currency, the Office of the Thrift Supervisors and the Federal Deposit Insurance Corporation (the “Agencies”).

The final guidance contains three key principles that banking organizations should follow to ensure that compensation incentives do not encourage employees to take risks that could jeopardize the safety and soundness of the organization.  These principles are:

  • Incentive compensation arrangements at a banking organization should provide employees incentives that appropriately balance risk and financial results in a manner that does not encourage employees to expose their organizations to imprudent risk.
  • These arrangements should be compatible with effective controls and risk-management.
  • These arrangements should be supported by strong corporate governance, including active and effective oversight by the organization’s board of directors.

The final guidance provides banking organizations with considerable flexibility in structuring their incentive compensation arrangements in ways that both promote safety and soundness and that help achieving the arrangement’s other objectives.  It does not impose any pay cap requirement or use a “one size fits all” approach.  It also includes several provisions designed to reduce burdens on smaller banking organizations and other banking organizations that are not significant users of incentive compensation.  Large banking organizations (“LBOs”) are expected to develop and adhere to more systematic and formalized policies, procedures and processes relating to incentive compensation.

The FRB also announced that the Agencies’ special horizon review of incentive compensation at the LBOs is well underway.  The Agencies intend to continue to regularly review incentive compensation arrangements at LBOs through the supervisory process.  The review of incentive compensation at other banking organizations will be part of the regular, risk‑focused examination process for those organizations.