View original document

The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.

Federal Register / Vol. 74, No. 206 / Tuesday, October 27, 2009 / Notices
Section 76.75 requires that each
MVPD employment unit shall establish,
maintain and carry out a program to
assure equal opportunity in every aspect
of a cable entity’s policy and practice.
Section 76.79 requires that every
MVPD employment unit maintain, for
public inspection, a file containing
copies of all annual employment reports
and related documents.
Section 76.1702 requires that every
MVPD place certain information
concerning its EEO program in the
public inspection file.
Federal Communications Commission.
Marlene H. Dortch,
Secretary.
[FR Doc. E9–25814 Filed 10–26–09; 8:45 am]
BILLING CODE: 6712–01–S

pwalker on DSK8KYBLC1PROD with NOTICES

BILLING CODE 6210–01–S

Sunshine Act Meeting

Formations of, Acquisitions by, and
Mergers of Bank Holding Companies
The companies listed in this notice
have applied to the Board for approval,
pursuant to the Bank Holding Company
Act of 1956 (12 U.S.C. 1841 et seq.)
(BHC Act), Regulation Y (12 CFR Part
225), and all other applicable statutes
and regulations to become a bank
holding company and/or to acquire the
assets or the ownership of, control of, or
the power to vote shares of a bank or
bank holding company and all of the
banks and nonbanking companies
owned by the bank holding company,
including the companies listed below.
The applications listed below, as well
as other related filings required by the
Board, are available for immediate
inspection at the Federal Reserve Bank
indicated. The applications also will be
available for inspection at the offices of
the Board of Governors. Interested
persons may express their views in
writing on the standards enumerated in
the BHC Act (12 U.S.C. 1842(c)). If the
proposal also involves the acquisition of
a nonbanking company, the review also
includes whether the acquisition of the
nonbanking company complies with the
standards in section 4 of the BHC Act
(12 U.S.C. 1843). Unless otherwise
noted, nonbanking activities will be
conducted throughout the United States.
Additional information on all bank
holding companies may be obtained
from the National Information Center
website at www.ffiec.gov/nic/.
Unless otherwise noted, comments
regarding each of these applications
must be received at the Reserve Bank
indicated or the offices of the Board of
Governors not later than November 20,
2009.

16:45 Oct 26, 2009

Board of Governors of the Federal Reserve
System, October 22, 2009.
Margaret McCloskey Shanks,
Associate Secretary of the Board.
[FR Doc. E9–25771 Filed 10–26–09; 8:45 am]

FEDERAL RESERVE SYSTEM

FEDERAL RESERVE SYSTEM

VerDate Nov<24>2008

A. Federal Reserve Bank of Atlanta
(Steve Foley, Vice President) 1000
Peachtree Street, N.E., Atlanta, Georgia
30309:
1. TWO ROA, LLC, Huntsville,
Alabama; to become a bank holding
company by acquiring 51 percent of the
voting shares of RB Bancorporation, and
Reliance Bank, both of Athens,
Alabama.

Jkt 220001

Board of
Governors of the Federal Reserve
System.
AGENCY HOLDING THE MEETING:

TIME AND DATE: 12 p.m., Monday,
November 2, 2009.
PLACE: Marriner S. Eccles Federal
Reserve Board Building, 20th and C
Streets, N.W., Washington, D.C. 20551.
STATUS:

Closed.

MATTERS TO BE CONSIDERED:

1. Personnel actions (appointments,
promotions, assignments,
reassignments, and salary actions)
involving individual Federal Reserve
System employees.
2. Any items carried forward from a
previously announced meeting.
FOR FURTHER INFORMATION CONTACT:
Michelle Smith, Director, or Dave
Skidmore, Assistant to the Board, Office
of Board Members at 202–452–2955.

You may
call 202–452–3206 beginning at
approximately 5 p.m. two business days
before the meeting for a recorded
announcement of bank and bank
holding company applications
scheduled for the meeting; or you may
contact the Board’s Web site at http://
www.federalreserve.gov for an electronic
announcement that not only lists
applications, but also indicates
procedural and other information about
the meeting.

SUPPLEMENTARY INFORMATION:

Board of Governors of the Federal Reserve
System, October 23, 2009.
Robert deV. Frierson,
Deputy Secretary of the Board.
[FR Doc. E9–25946 Filed 10–23–09; 4:15 pm]
BILLING CODE 6210–01–S

PO 00000

Frm 00047

Fmt 4703

Sfmt 4703

55227

FEDERAL RESERVE SYSTEM
[Docket No. OP–1374]

Proposed Guidance on Sound
Incentive Compensation Policies
AGENCY: Board of Governors of the
Federal Reserve System (Board).
ACTION: Proposed guidance with request
for public comment.
SUMMARY: The Board is requesting
comment on proposed guidance (the
‘‘guidance’’) designed to help ensure
that incentive compensation policies at
banking organizations do not encourage
excessive risk-taking and are consistent
with the safety and soundness of the
organization. The Federal Reserve also
is commencing two supervisory
initiatives to spur progress by the
banking industry in the development
and implementation of sound incentive
compensation arrangements, identify
emerging best practices, and advance
the state of practice more generally in
the banking industry. The Federal
Reserve expects all banking
organizations to evaluate their incentive
compensation arrangements and related
risk management, control, and corporate
governance processes and immediately
address deficiencies in these
arrangements or processes that are
inconsistent with safety and soundness.
DATES: Comments must be submitted on
or before November 27, 2009.
ADDRESSES: The Board will review all of
the comments submitted. Please
consider submitting your comments by
e-mail or fax since paper mail in the
Washington DC area and at the Board is
subject to delay. You may submit
comments, identified by Docket No.
OP–1374, by any of the following
methods:
• Agency Web Site: http://
www.federalreserve.gov. Follow the
instructions for submitting comments at
http://www.federalreserve.gov/
generalinfo/foia/ProposedRegs.cfm.
• Federal eRulemaking Portal: http://
www.regulations.gov. Follow the
instructions for submitting comments.
• E-mail: regs.comments@
federalreserve.gov. Include the docket
number in the subject line of the
message.
• FAX: 202/452–3819 or 202/452–
3102.
• Mail: Jennifer J. Johnson, Secretary,
Board of Governors of the Federal
Reserve System, 20th Street and
Constitution Avenue, NW., Washington,
DC 20551.
All public comments are available from
the Board’s Web site at http://
www.federalreserve.gov/generalinfo/

E:\FR\FM\27OCN1.SGM

27OCN1

55228

Federal Register / Vol. 74, No. 206 / Tuesday, October 27, 2009 / Notices

foia/ProposedRegs.cfm as submitted,
unless modified for technical reasons.
Accordingly, your comments will not be
edited to remove any identifying or
contact information. Public comments
may also be viewed in electronic or
paper form in Room MP–500 of the
Board’s Martin Building (20th and C
Streets, NW.,) between 9 a.m. and 5 p.m.
on weekdays.
FOR FURTHER INFORMATION CONTACT:
Barbara J. Bouchard, Associate Director,
(202) 452–3072, William F. Treacy,
Adviser, (202) 452–3859, Robert
Motyka, Senior Project Manager, (202)
452–5231, Division of Banking
Supervision and Regulation; Mark S.
Carey, Adviser, (202) 452–2784,
Division of International Finance; or
Kieran J. Fallon, Assistant General
Counsel, (202) 452–5270, or Michael W.
Waldron, Counsel, (202) 452–2798,
Legal Division. For users of
Telecommunications Device for the Deaf
(‘‘TDD’’) only, contact (202) 263–4869.
SUPPLEMENTARY INFORMATION:

pwalker on DSK8KYBLC1PROD with NOTICES

I. Background
Incentive compensation practices in
the financial services industry were one
of many factors contributing to the
financial crisis that began in 2007.
Banking organizations too often
rewarded employees for increasing the
firm’s short-term revenue or profit
without adequate recognition of the
risks the employees’ activities posed for
the firm. Importantly, problematic
compensation practices were not
limited to the most senior executives at
financial firms. Compensation practices
can incent employees at various levels
of a banking organization, either
individually or as a group, to undertake
imprudent risks that can significantly
and adversely affect the risk profile of
the firm.
Supervisory attention and action is
necessary to address the potential for
incentive compensation arrangements to
encourage employees to take excessive
risks on behalf of their organization.
Shareholders of a banking organization
cannot directly control the day-to-day
operations of the firm—especially a
large and complex firm—and must rely
on the firm’s management to do so,
subject to direction and oversight by
shareholder-elected boards of directors.
Incentive compensation arrangements
are one way that firms can encourage
managers and other employees to take
actions that are consistent with the
interests of shareholders by
appropriately rewarding behavior that
increases the organization’s revenue,
profits, or other measures of
performance. However, flawed

VerDate Nov<24>2008

16:45 Oct 26, 2009

Jkt 220001

compensation programs can incentivize
employees to take additional risk
beyond the firm’s tolerance for, or
ability to manage, risk in order to
increase the employees’ personal
compensation. Shareholders have an
interest in ensuring that incentive
compensation arrangements do not
encourage employees to take risks
beyond the risk tolerance of
shareholders.
Aligning the interests of shareholders
and employees, however, is not always
sufficient to protect the safety and
soundness of a banking organization.
Because of the protections offered by the
federal safety net, shareholders of a
banking organization in some cases may
be willing to tolerate a degree of risk
that is inconsistent with the
organization’s safety and soundness.
Thus, a review of incentive
compensation arrangements and related
corporate governance practices to
ensure that they are effective from the
standpoint of shareholders is not
sufficient to ensure they adequately
protect the safety and soundness of the
organization.
In addition, supervisors can provide a
common prudential foundation for
incentive compensation arrangements
across banking organizations and
promote the overall movement of the
industry toward better practices. Even if
the owners or managers of an individual
firm do not like the way compensation
is structured at their firm, they may be
unwilling to make unilateral changes
because doing so might mean losing
valuable employees and business to
other firms. Supervisory action can play
a critical role in addressing this ‘‘first
mover’’ problem that may make it
difficult for individual firms to act alone
in addressing misaligned incentives.
Through their actions, supervisors can
help to better align the interests of
managers and other employees with the
long-term health of the organization,
and also reduce firms’ concerns that
making prudent modifications to their
incentive compensation arrangements
might have adverse competitive
consequences.
II. Federal Reserve Guidance
The Federal Reserve has developed
the attached guidance to help protect
the safety and soundness of banking
organizations and promote the prompt
improvement of incentive compensation
practices throughout the banking
industry.1 The guidance is based on
1 As used in the guidance, the term ‘‘banking
organization’’ includes U.S. bank holding
companies, state member banks, Edge and
agreement corporations, and the U.S. operations of

PO 00000

Frm 00048

Fmt 4703

Sfmt 4703

three key principles that are designed to
ensure that incentive compensation
arrangements at a banking organization
do not encourage employees to take
excessive risks. These principles
provide that incentive compensation
arrangements at a banking organization
should—
• Provide employees incentives that
do not encourage excessive risk-taking
beyond the organization’s ability to
effectively identify and manage risk;
• Be compatible with effective
controls and risk management; and
• Be supported by strong corporate
governance, including active and
effective oversight by the organization’s
board of directors.
These principles, and the types of
policies, procedures, and systems that
banking organizations should have to
help ensure compliance with these
principles, are discussed in more detail
in the attached proposed guidance.
These principles and the guidance are
consistent with the Principles for Sound
Compensation Practices adopted by the
Financial Stability Board (FSB) in April
2009, as well as the Implementation
Standards for those principles issued by
the FSB in September 2009.
Because incentive compensation
arrangements for executive and nonexecutive employees may pose safety
and soundness risks if not properly
structured, the proposed guidance
applies to senior executives as well as
other employees who, either
individually or as part of a group, may
expose the relevant banking
organization to material amounts of risk.
In addition, implementation of the
guidance by a banking organization
should be appropriate in light of the
scope and complexity of the
organization’s activities, as well as the
prevalence and scope of its incentive
compensation arrangements. Thus, for
example, the reviews, policies,
procedures, and systems implemented
by a small banking organization that
uses incentive compensation
arrangements on a limited basis will be
substantially less extensive, formalized,
and detailed than those at large,
complex banking organization that uses
incentive compensation arrangements
extensively.
The Board invites comment on all
aspects of the guidance. In particular,
are the three core principles described
in the guidance appropriate and
sufficient to help ensure that incentive
compensation arrangements do not
threaten the safety and soundness of
banking organizations? Should
foreign banks with a branch, agency, or commercial
lending company subsidiary in the United States.

E:\FR\FM\27OCN1.SGM

27OCN1

pwalker on DSK8KYBLC1PROD with NOTICES

Federal Register / Vol. 74, No. 206 / Tuesday, October 27, 2009 / Notices
additional or different principles be
included to achieve this goal? To what
extent are the current incentive
compensation arrangements of banking
organizations consistent with the
principles set forth in the guidance and
are there material legal, regulatory, or
other impediments to the prompt
implementation of incentive
compensation arrangements and related
processes that would be consistent with
these principles?
In addition, some have suggested that
one or more formulaic limits be adopted
for some or all banking organizations,
and, in particular, have suggested
consideration of an approach in which
at least 60 percent of all incentive
compensation received by senior
executives of all large, complex banking
organizations be deferred and at least 50
percent of incentive compensation be
paid in the form of stock, options, or
other equity-linked instruments. Would
such formulaic limits on determining
and paying incentive compensation
likely promote the long-term safety and
soundness of banking organizations
generally if applied to certain types or
classes of executive or non-executive
employees across all or certain types of
banking organizations? If so, what are
those classes of executives, employees
and institutions, and what formulaic
limits would be most effective?
Moreover, would market forces or
practices in the broader financial
services industry, such as the use of
‘‘golden parachute’’ or ‘‘golden
handshake’’ arrangements to retain or
attract employees, present challenges for
banking organizations in developing
and maintaining balanced incentive
compensation arrangements? If so, what
types of statutory, regulatory, or privatesector actions might help mitigate these
challenges?
Further, the Board seeks comment on
whether the proposed guidance would
impose undue burdens on, or have
unintended consequences for, banking
organizations and, particularly, regional
and small organizations, and whether
there are ways such potential burdens or
consequences could be addressed in a
manner consistent with safety and
soundness. Also, are there types of
incentive compensation plans, such as
firm-wide profit sharing plans that
provide for distributions in a manner
that is not materially linked to the
performance of specific employees or
groups of employees, that could and
should be exempted from, or treated
differently under, the guidance because
they are unlikely to affect the risk-taking
incentives of all, or a significant number
of, employees? If so, what are the
features of these plans and the types of

VerDate Nov<24>2008

16:45 Oct 26, 2009

Jkt 220001

employees for which they are unlikely
to affect risk-taking behavior?
III. Federal Reserve Supervisory
Initiatives
The Federal Reserve expects all
banking organizations to evaluate their
incentive compensation arrangements
and related risk management, control,
and corporate governance processes and
immediately address deficiencies in
these arrangements or processes that are
inconsistent with safety and soundness.
Banking organizations are responsible
for ensuring that their incentive
compensation arrangements are
consistent with the principles described
in the guidance, do not encourage
excessive risk-taking, and do not pose a
threat to the safety and soundness of the
organization.
The Federal Reserve is committed to
moving the banking industry forward to
incorporate the principles described in
the guidance into incentive
compensation practices. Accordingly, in
addition to proposing guidance, the
Federal Reserve is commencing the
following two supervisory initiatives to
spur and monitor the industry’s
progress towards the implementation of
safe and sound incentive compensation
arrangements, identify emerging best
practices, and advance the state of
practice more generally in the industry:
• A special horizontal review of
incentive compensation practices at
large complex banking organizations
(LCBOs); and
• A review of incentive compensation
practices at other banking organizations
as part of the risk-focused examination
process for these organizations.
LCBOs warrant special supervisory
attention because they are significant
users of incentive compensation
arrangements and because the adverse
effects of flawed approaches at these
institutions are more likely to have
adverse effects on the broader financial
system.2 As part of the horizontal
review of these firms, each LCBO will
2 An important aspect of the Federal Reserve’s
consolidated supervision programs for bank holding
companies and the combined U.S. operations of
foreign banking organizations is the assessment and
evaluation of practices across groups of
organizations with similar characteristics and risk
profiles. LCBOs are characterized by the scope and
complexity of their domestic and international
operations; their participation in large volume
payment and settlement systems; the extent of their
custody operations and fiduciary activities; and the
complexity of their regulatory structures, both
domestically and in foreign jurisdictions. To be
designated as an LCBO, a banking organization
must meet specified criteria to be considered a
significant participant in at least one key financial
market. See SR letter 08–9, Consolidated
Supervision of Bank Holding Companies and the
Combined U.S. Operations of Foreign Banking
Organization (Oct. 16, 2008).

PO 00000

Frm 00049

Fmt 4703

Sfmt 4703

55229

be expected to provide the Federal
Reserve information and documentation
that clearly describes the organization’s
current incentive compensation
practices and its plans (including
timetables) for improving these
practices.
The horizontal review of LCBOs will
be led by Board staff, working with
relevant Reserve Bank supervisors, and
will draw on a multidisciplinary group
comprised of staff with expertise in
banking supervision, risk management,
economics, finance, law, accounting,
and other areas as appropriate. This
multidisciplinary team also will have
access to information and analysis
developed as part of the reviews of other
banking organizations, and will serve as
a resource for supervisory staff across
the System on incentive compensation
matters.
The Federal Reserve will work closely
with each LCBO to ensure that its plans
are likely to result in the establishment
and maintenance of incentive
compensation arrangements that do not
encourage excessive risk-taking. The
Federal Reserve also will supervise
these organizations to ensure that these
plans are fully implemented in a timely
manner.
In the second initiative, the Federal
Reserve will review incentive
compensation arrangements at nonLCBO banking organizations as part of
risk management reviews during the
regular, risk-focused examination
process. As with other aspects of the
examination process, these reviews will
be tailored to reflect the scope and
complexity of the organization’s
activities, as well as the prevalence and
scope of the organization’s incentive
compensation arrangements.3
For LCBOs and other organizations,
supervisory findings will be included in
the relevant report of examination or
inspection, communicated to the
organization, and incorporated, as
appropriate, into the organization’s
supervisory ratings. The Federal Reserve
in appropriate circumstances may take
enforcement action against a banking
organization if its incentive
compensation arrangements or related
risk management, control, or governance
processes pose a risk to the safety and
soundness of the organization and the
organization is not taking prompt and
3 Similarly, for foreign banking organizations, the
management of U.S. operations will be assessed
with regard to the consistency of incentive
compensation arrangements and related processes
with the principles set forth in this guidance, taking
into account the size and complexity of U.S.
operations. See SR letter 08–9, Consolidated
Supervision of Bank Holding Companies and the
Combined U.S. Operations of Foreign Banking
Organizations (Oct. 16, 2008).

E:\FR\FM\27OCN1.SGM

27OCN1

55230

Federal Register / Vol. 74, No. 206 / Tuesday, October 27, 2009 / Notices

pwalker on DSK8KYBLC1PROD with NOTICES

effective measures to correct the
deficiencies. Where appropriate, such
an action may require an organization to
develop a corrective action plan that is
acceptable to the Federal Reserve to
rectify deficiencies in its incentive
compensation arrangements or related
processes.
Additional information concerning
these supervisory initiatives is provided
in the guidance. Effective and balanced
incentive compensation practices are
likely to evolve significantly in the
coming years, spurred by the efforts of
banking organizations, supervisors, and
other stakeholders. The Federal Reserve
will review and update the guidance as
appropriate to incorporate best practices
that emerge from these efforts. In
addition, in order to monitor and
encourage improvements, Federal
Reserve staff will prepare a report on
trends and developments in
compensation practices at banking
organizations after the conclusion of
2010.
IV. Other Matters
In accordance with the Paperwork
Reduction Act (PRA) of 1995 (44 U.S.C.
3506; 5 CFR Part 1320 Appendix A.1),
the Board reviewed the proposed
guidance under the authority delegated
to the Board by the Office of
Management and Budget (OMB). The
Board has determined that certain
aspects of the proposed guidance may
constitute a collection of information. In
particular, these aspects are the
provisions that state a banking
organization should (i) have policies
and procedures that identify and
describe the role(s) of the personnel and
units authorized to be involved in
incentive compensation arrangements,
identify the source of significant riskrelated inputs, establish appropriate
controls governing these inputs to help
ensure their integrity, and identify the
individual(s) and unit(s) whose
approval is necessary for the
establishment or modification of
incentive compensation arrangements;
(ii) create and maintain sufficient
documentation to permit an audit of the
organization’s processes for incentive
compensation arrangements; (iii) have
any material exceptions or adjustments
to the incentive compensation
arrangements established for senior
executives approved and documented
by its board of directors; and (iv) have
its board of directors receive and
review, on an annual or more frequent
basis, an assessment by management of
the effectiveness of the design and
operation of the organization’s incentive
compensation system in providing risktaking incentives that are consistent

VerDate Nov<24>2008

16:45 Oct 26, 2009

Jkt 220001

with the organization’s safety and
soundness. The Federal Reserve
estimates that the above-described
information collections included in the
proposed guidance would take
respondents, on average, 40 hours each
year. Any changes to the Federal
Reserve’s regulatory reporting forms that
may be made in the future to collect
information related to incentive
compensation arrangements would be
addressed in a separate Federal Register
notice. The Board may not conduct or
sponsor, and an organization is not
required to respond to, an information
collection unless the information
collection displays a currently valid
OMB control number.
For purposes of the PRA, this
information collection will be titled
Recordkeeping Provisions Associated
with the Incentive Compensation
Guidance. The agency form number for
the collection is FR 4027. The agency
control number for this new collection
will be assigned by OMB.
This information collection is
authorized pursuant to sections 11(a),
11(i), 25, and 25A of the Federal Reserve
Act (12 U.S.C. 248(a), 248(i), 602, and
611), section 5 of the Bank Holding
Company Act (12 U.S.C. 1844), and
section 7(c) of the International Banking
Act (12 U.S.C. 3105(c)). The Board
expects to review the policies and
procedures for incentive compensation
arrangements as part of the Board’s
supervisory process. To the extent the
Board collects information during an
examination of a banking organization,
confidential treatment may be afforded
to the records under exemption 8 of the
Freedom of Information Act (FOIA), 5
U.S.C. 552(b)(8).
The frequency of information
collection is estimated to be annual.
Respondents are banking organizations
as defined in the guidance, which total
6,889. The estimated annual reporting
hours are 275,560.
Comments on the collection of
information should be sent to Michelle
Shore, Federal Reserve Board Clearance
Officer, Division of Research and
Statistics, Mail Stop 95–A, Board of
Governors of the Federal Reserve
System, Washington, DC 20551, with
copies of such comments sent to the
Office of Management and Budget,
Paperwork Reduction Project (Docket
No. OP–1374), Washington, DC 20503.
Comments are invited on:
(1) Whether the proposed collection
of information is necessary for the
proper performance of the Federal
Reserve’s functions; including whether
the information has practical utility;
(2) The accuracy of the Federal
Reserve’s estimate of the burden of the

PO 00000

Frm 00050

Fmt 4703

Sfmt 4703

proposed information collection,
including the cost of compliance;
(3) Ways to enhance the quality,
utility, and clarity of the information to
be collected; and
(4) Ways to minimize the burden of
information collection on respondents,
including through the use of automated
collection techniques or other forms of
information technology.
While the guidance is not being
adopted as a rule, the Board also has
considered the potential impact of the
proposed guidance on small banking
organizations in accordance with the
Regulatory Flexibility Act (5 U.S.C.
603(b)). For the reasons discussed in the
‘‘Supplementary Information’’ above,
the Board believes that issuance of the
proposed guidance is needed to help
ensure that incentive compensation
arrangements do not pose a threat to the
safety and soundness of banking
organizations, including small banking
organizations.
It is estimated that the proposed
guidance, if adopted in final form,
would apply to 3002 small banking
organizations (defined as banking
organizations with $175 million or less
in total assets). See 13 CFR 121.201. The
Board has focused the guidance on
those employees who have the ability,
either individually or as part of a group,
to expose a banking organization to
material amounts of risk. In addition,
the Board has sought to tailor the
guidance and its supervisory initiatives
to account for the differences between
large and small banking organizations
and has provided that, in conducting
reviews of small banking organizations
as part of the regular examination
process, the Federal Reserve will take
into account the scope and complexity
of the organization’s activities, as well
as the prevalence and scope of its
incentive compensation arrangements.
In light of the foregoing, the Board does
not believe that the proposed guidance,
if adopted in final form, would have a
significant economic impact on a
substantial number of small entities. As
noted above, the Board specifically
seeks comment on whether the
proposed guidance would impose
undue burdens on, or have unintended
consequences for, small organizations
and whether there are ways such
potential burdens or consequences
could be addressed in a manner
consistent with safety and soundness.
V. Proposed Guidance
The text of the proposed guidance is
as follows:

E:\FR\FM\27OCN1.SGM

27OCN1

Federal Register / Vol. 74, No. 206 / Tuesday, October 27, 2009 / Notices

pwalker on DSK8KYBLC1PROD with NOTICES

I. Introduction
Incentive compensation practices in
the financial industry were one of many
factors contributing to the financial
crisis. Banking organizations too often
rewarded employees for increasing the
firm’s revenue or short-term profit
without adequate recognition of the
risks the employees’ activities posed to
the firm. These practices exacerbated
the risks and losses at a number of
banking organizations and resulted in
the misalignment of the interests of
employees with the long-term well
being and safety and soundness of their
organizations.
This document provides guidance on
sound compensation practices to
banking organizations supervised by the
Federal Reserve.1 Alignment of the
incentives provided to employees with
the interests of shareholders of the
organization often also furthers safety
and soundness. However, aligning those
interests is not always sufficient to
address safety and soundness concerns.
Because of the presence of the federal
safety net, shareholders of a banking
organization in some cases may be
willing to tolerate a degree of risk that
is inconsistent with the organization’s
safety and soundness. Accordingly, the
Federal Reserve expects banking
organizations to maintain incentive
compensation practices that are
consistent with safety and soundness,
even when these practices go beyond
those needed to align shareholder and
employee interests.
To be consistent with safety and
soundness, incentive compensation
arrangements at a banking organization
should:
• Provide employees incentives that
do not encourage excessive risk-taking
beyond the organization’s ability to
effectively identify and manage risk;
• Be compatible with effective
controls and risk management; and
• Be supported by strong corporate
governance, including active and
effective oversight by the organization’s
board of directors.
These principles, and the types of
policies, procedures, and systems that
banking organizations should have to
help ensure compliance with these
principles, are discussed in Part II of
this guidance.
The Federal Reserve expects all
banking organizations to evaluate their
incentive compensation arrangements
1 As used in this guidance, the term ‘‘banking
organizations’’ includes U.S. bank holding
companies, state member banks, Edge and
agreement corporations, and the U.S. operations of
foreign banks with a branch, agency, or commercial
lending company in the United States.

VerDate Nov<24>2008

16:45 Oct 26, 2009

Jkt 220001

for executive and non-executive
employees who, either individually or
as part of a group, have the ability to
expose the firm to material amounts of
risk and the risk management, control,
and corporate governance processes
related to these arrangements. Banking
organizations should immediately
address deficiencies in these
arrangements or processes that are
inconsistent with safety and soundness.
Banking organizations are responsible
for ensuring that their incentive
compensation arrangements are
consistent with the principles described
in this guidance and do not encourage
excessive risk-taking or pose a threat to
the safety and soundness of the
organization.2
Designing and implementing
compensation arrangements that
properly incent employees to pursue the
organization’s long-term well being and
that do not encourage excessive risktaking is a complex task and one that
requires the commitment of adequate
resources. The Federal Reserve
recognizes that incentive compensation
arrangements often seek to serve several
important and worthy objectives.3 It is
important that incentive compensation
arrangements be properly structured for
all employees at a banking organization,
including non-executive employees,
who have the ability, either individually
or as a group, to take material risks. The
analysis and methods for making
incentive compensation arrangements
take appropriate account of risk also
should be tailored to the business
model, risk tolerance, size, and
complexity of each firm. Thus,
achieving and sustaining adherence to
sound practices will present challenges.
While the issues are complex, the
Federal Reserve is committed to moving
banking organizations forward to
incorporate the principles described in
this guidance into incentive
compensation practices. To help
accomplish this, the Federal Reserve is
commencing two supervisory
initiatives:
• A special horizontal review of
incentive compensation practices at
2 In this guidance, the term ‘‘incentive
compensation’’ refers to that portion of an
employee’s current or potential compensation that
is tied to achievement of one or more specific
metrics (e.g., a level of sales, revenue, or income).
Incentive compensation does not include
compensation that is awarded solely for, and the
payment of which is tied to, continued employment
(e.g., salary).
3 For example, incentive compensation
arrangements may be used to help attract skilled
staff, promote better firm and employee
performance, promote employee retention, provide
retirement security to employees, or provide a
closer tie between compensation expenses and
revenue on a firm-wide basis.

PO 00000

Frm 00051

Fmt 4703

Sfmt 4703

55231

large, complex banking organizations;
and
• A review of incentive compensation
practices at other banking organizations
as part of the regular risk-focused
examination process for these
organizations.
These initiatives, which are described in
greater detail in Part III of this guidance,
are designed to spur and monitor
progress toward safe and sound
incentive compensation arrangements,
identify emerging best practices, and
advance the state of practice more
generally in the industry.
The Federal Reserve expects to
commence promptly the horizontal
review of large, complex banking
organizations (LCBOs). As part of this
review, each LCBO will be expected to
provide the Federal Reserve with,
among other things, the organization’s
plans, including relevant timetables, for
improving the risk-sensitivity of its
incentive compensation arrangements
and related risk management, controls,
and corporate governance practices. The
Federal Reserve will work with these
organizations as necessary through the
supervisory process to ensure that they
produce plans that will promptly result
in incentive compensation arrangements
that are consistent with safety and
soundness, and will supervise the
organizations to ensure that these plans
are fully implemented in an expeditious
manner.
To promote consistency and to
leverage the resources available at the
Federal Reserve, the horizontal review
of LCBOs will be led by Board staff,
working with Reserve Bank supervisors
responsible for LCBOs. This
coordinating group will be comprised of
staff with expertise in banking
supervision, risk management,
economics, finance, law, accounting,
and other areas as appropriate. This
multidisciplinary team also will have
access to information and analysis
developed as part of the reviews of other
banking organizations and will serve as
a resource for supervisory staff across
the System on incentive compensation
matters.
As part of the supervisory process for
all banking organizations, the Federal
Reserve will assess the potential for
incentive compensation arrangements to
encourage excessive risk-taking, the
actions an organization has taken or
proposes to take to correct deficiencies,
and the adequacy of the organization’s
compensation-related risk management,
control, and corporate governance
processes. Reviews at regional and
community banking organizations will
be conducted as part of the evaluation

E:\FR\FM\27OCN1.SGM

27OCN1

55232

Federal Register / Vol. 74, No. 206 / Tuesday, October 27, 2009 / Notices

pwalker on DSK8KYBLC1PROD with NOTICES

the firm’s risk management, internal
controls, and corporate governance
during the regular examination
process.4 These reviews will be tailored
to reflect the scope and complexity of
the organization’s activities, as well as
the prevalence and scope of its
incentive compensation arrangements.
In this regard, the compensation-related
policies, procedures, and systems at a
small banking organization that uses
incentive compensation arrangements
on a limited basis will be substantially
less extensive, formalized, and detailed
than those of an LCBO that uses
incentive compensation arrangements
extensively.
Supervisory findings for all types of
organizations will be included in the
relevant report of examination or
inspection and communicated to the
organization.5 In addition, these
findings will be incorporated, as
appropriate, into the organization’s
rating component(s) and
subcomponent(s) relating to risk
management, internal controls, and
corporate governance under the relevant
supervisory rating system, as well as the
organization’s overall supervisory
rating.6
In appropriate circumstances, the
Federal Reserve may take enforcement
action against a banking organization if
its incentive compensation
arrangements or related risk
management, control, or governance
processes pose a risk to the safety and
soundness of the organization and the
organization is not taking prompt and
effective measures to correct the
deficiencies. For example, the Federal
Reserve may take an enforcement action
it considers appropriate against an
LCBO if the organization fails to
develop, submit, or adhere to an
effective plan designed to ensure that
the organization’s incentive
compensation arrangements do not
encourage excessive risk-taking and are
consistent with principles of safety and
soundness. As provided under section 8
of the Federal Deposit Insurance Act (12
4 Thus, for example, reviews at bank holding
companies with total consolidated assets of $5
billion or less will be conducted in accordance with
the risk-focused supervision program for these
organizations. See SR letter 02–1, Revisions to Bank
Holding Company Supervision Procedures for
Organizations with Total Consolidated Assets of $5
Billion or Less (Jan. 9, 2002).
5 See SR letter 08–1, Communication of
Examination/Inspection Findings (Jan. 24, 2008).
6 For example, supervisory findings for bank
holding companies in the areas discussed in this
guidance should be incorporated into the
assessment of the appropriate subcomponent(s) for
the BHC’s ‘‘Risk Management’’ rating component in
the RFI (Risk Management, Financial Condition,
and Impact) rating. See SR letter 04–18, Bank
Holding Company Rating System (Dec. 6, 2004).

VerDate Nov<24>2008

16:45 Oct 26, 2009

Jkt 220001

U.S.C. 1818), an enforcement action
may, among other things, require an
organization to develop a corrective
action plan that is acceptable to the
Federal Reserve to rectify deficiencies in
its incentive compensation
arrangements or related processes.
Where warranted, the Federal Reserve
may require the organization to take
affirmative action to correct or remedy
deficiencies related to the organization’s
incentive compensation practices until
its corrective action plan is
implemented.
Effective and balanced incentive
compensation practices are likely to
evolve significantly in the coming years,
spurred by the efforts of banking
organizations, supervisors, and other
stakeholders. The Federal Reserve will
review and update this guidance as
appropriate to incorporate best practices
that emerge from these efforts.
II. Principles of a Sound Incentive
Compensation System
The incentive compensation
arrangements and related policies and
procedures of banking organizations
should be consistent with principles of
safety and soundness.7 This guidance is
intended to assist banking organizations
in designing and implementing
incentive compensation arrangements
and related policies and procedures that
effectively take account of potential
risks and risk outcomes.8 Because
incentive compensation arrangements
for executive and non-executive
personnel who have the ability to
expose a banking organization to
material amounts of risk may, if not
properly structured, pose a threat to the
organization’s safety and soundness,
this guidance applies to incentive
compensation arrangements for:
• Senior executives and others who
are responsible for oversight of the
organization’s firm-wide activities or
material business lines;
• Individual employees, including
non-executive employees, whose
activities may expose the firm to
material amounts of risk (e.g., traders
7 In the case of the U.S. operations of foreign
banks, the organization’s policies, including
management, review, and approval requirements,
should be coordinated with the foreign bank’s
group-wide policies developed in accordance with
the rules of the foreign bank’s home country
supervisor and should be consistent with the
foreign bank’s overall corporate and management
structure as well as its framework for risk
management and internal controls.
8 This guidance and the principles reflected
herein are consistent with the Principles for Sound
Compensation Practices issued by the Financial
Stability Board (FSB) in April 2009, and with the
FSB’s Implementation Standards for those
principles, issued in September 2009.

PO 00000

Frm 00052

Fmt 4703

Sfmt 4703

with large position limits relative to the
firm’s overall risk tolerance); and
• Groups of employees who are
subject to the same or similar incentive
compensation arrangements and who, in
the aggregate, may expose the firm to
material amounts of risk, even if no
individual employee is likely to expose
the firm to material risk (e.g., loan
officers who, as a group, originate loans
that account for a material amount of
the organization’s credit risk).
For ease of reference, these executive
and non-executive employees are
collectively referred to as ‘‘employees.’’
Depending on the facts and
circumstances of the individual
organization, jobs and job families that
are outside the scope of this guidance
because they do not have the ability to
expose the organization to material risks
may include, for example, tellers,
bookkeepers, couriers, or data
processing personnel.
Principle 1: Balanced Risk-Taking
Incentives
Incentive compensation arrangements
should balance risk and financial results
in a manner that does not provide
employees incentives to take excessive
risks on behalf of the banking
organization.
Incentive compensation arrangements
typically attempt to encourage actions
that result in greater revenue or profit
for the firm. However, short-run revenue
or profit can often diverge sharply from
actual long-run profit because risk
outcomes may become clear only over
time. Activities that carry higher risk
typically yield higher short-term
revenue, and an employee who is given
incentives to increase short-term
revenue or profit, without regard to risk,
will naturally be attracted to
opportunities to take more risk.
An incentive compensation
arrangement is balanced when the
amounts paid to an employee
appropriately take into account the
risks, as well as the financial benefits,
from the employee’s activities and the
impact of those activities on the
organization’s safety and soundness. As
an example, under a balanced incentive
compensation arrangement, two
employees who generate the same
amount of short-term revenue or profit
for an organization should not receive
the same amount of incentive
compensation if the risks taken by the
employees in generating that revenue or
profit differ materially. The employee
whose activities create materially larger
risks for the organization should receive
less than the other employee, all else
being equal.

E:\FR\FM\27OCN1.SGM

27OCN1

Federal Register / Vol. 74, No. 206 / Tuesday, October 27, 2009 / Notices

pwalker on DSK8KYBLC1PROD with NOTICES

The performance measures used in an
incentive compensation arrangement
have an important effect on the
incentives provided employees and,
thus, the potential for the arrangement
to encourage excessive risk-taking. For
example, if an employee’s incentive
compensation payments are closely tied
to short-term revenue or profit of
business generated by the employee,
without any adjustments for the risks
associated with the associated business,
the potential for the arrangement to
encourage excessive risk-taking may be
quite strong. On the other hand, if an
employee’s incentive compensation
payments are determined based on
performance measures that are only
distantly linked to the employee’s
activities (e.g., for most employees, firmwide profit), the potential for the
arrangement to encourage the employee
to take excessive risks on behalf of the
organization may be weak.9
Incentive compensation arrangements
should not only be balanced in design,
they also should be implemented so that
actual payments vary based on risks or
risk outcomes. If, for example,
employees are paid substantially all of
their potential incentive compensation
even when risk or risk outcomes are
materially worse than expected,
employees have less incentive to avoid
excessively risky activities.
• Banking organizations should
consider the full range of risks
associated with an employee’s activities,
as well as the time horizon over which
those risks may be realized, in assessing
whether incentive compensation
arrangements are balanced.
The activities of employees may
create a wide range of risks for a
banking organization, including credit,
market, liquidity, operational, legal,
compliance, and reputational risks.
Some of these risks may be realized in
the short term, while others may
become apparent only over the long
term. For example, future revenues that
are booked as current income may not
materialize, and short-term profit-andloss measures may not appropriately
reflect differences in the risks associated
with the revenue derived from different
9 Similarly, the size of an employee’s incentive
compensation payments in relation to the
employee’s total compensation package may affect
the likelihood that the incentive compensation
arrangement may induce the employee to take
excessive risks. For example, where incentive
compensation is a small portion of employees’ total
compensation—as is the case for many employees
at regional and community banking organizations—
such compensation is less likely to affect the
employees’ risk-taking behavior than when
incentive compensation represents a large
percentage, or even a majority, of the employees’
total compensation.

VerDate Nov<24>2008

16:45 Oct 26, 2009

Jkt 220001

activities (e.g., the higher credit or
compliance risk associated with
subprime loans versus prime loans).10 In
addition, some risks may have a low
probability of being realized, but would
have highly adverse effects on the
organization if they were to be realized
(‘‘bad-tail risks’’). While shareholders
may have less incentive to guard against
bad-tail risks because of their
infrequency and the existence of the
federal safety net, these risks warrant
special attention from a safety-andsoundness perspective given the threat
they pose to the organization’s solvency
and the federal safety net.
Banking organizations should
consider the full range of current and
potential risks associated with the
activities of employees, including the
cost and amount of capital and liquidity
needed to support those risks, in
developing balanced incentive
compensation arrangements. Reliable
quantitative measures of risk and risk
outcomes (‘‘quantitative measures’’),
where available, may be particularly
useful in developing balanced
compensation arrangements and in
assessing the extent to which
arrangements are properly balanced.
However, reliable quantitative measures
may not be available for all types of risk
or for all activities, and their utility for
use in compensation arrangements
varies across business lines and
employees. The absence of reliable
quantitative measures for certain types
of risks or outcomes does not mean that
banking organizations should ignore
such risks or outcomes for purposes of
assessing whether an incentive
compensation arrangement achieves
balance. For example, while reliable
quantitative measures may not exist for
many bad-tail risks, it is important that
such risks be considered given their
potential effect on safety and soundness.
As in other risk-management areas,
banking organizations should rely on
informed judgments to estimate risks
and risk outcomes in the absence of
reliable quantitative risk measures.11
10 Importantly, the time horizon over which a risk
outcome may be realized is not necessarily the same
as the stated maturity of an exposure. For example,
the ongoing reinvestment of funds by a cash
management unit in commercial paper with a oneday maturity not only exposes the organization to
one-day credit risk, but also exposes the
organization to liquidity risk that may be realized
only infrequently.
11 Where judgment plays a significant role in the
design or operation of an incentive compensation
arrangement, strong internal controls and ex post
monitoring of incentive compensation payments
relative to actual risk outcomes are particularly
important to help ensure that the arrangements as
implemented do not encourage excessive risktaking.

PO 00000

Frm 00053

Fmt 4703

Sfmt 4703

55233

Banking organizations, and
particularly large, complex
organizations, should consider using
scenario analysis to help assess whether
the features included in incentive
compensation arrangements are likely to
achieve balance over time. Scenario
analysis of incentive compensation
arrangements involves the evaluation of
payments on a forward-looking basis
based on a range of performance levels,
risk outcomes, and the levels of risks
taken. This type of analysis can help an
organization assess whether incentive
compensation payments to an employee
are likely to be reduced appropriately as
the risks to the organization from the
employee’s activities increase.
• An unbalanced arrangement can be
moved toward balance by adding or
modifying features that cause the
amounts ultimately received by
employees to appropriately reflect risk
and risk outcomes.
If an incentive compensation
arrangement may encourage employees
to take excessive risks, the banking
organization should modify the
arrangement as needed to ensure that it
is consistent with safety and soundness.
Four methods currently are often used
to make compensation more sensitive to
risk. These methods are:
Æ Risk Adjustment of Awards: The
amount of an incentive compensation
award for an employee is adjusted based
on measures that take into account the
risk the employee’s activities pose to the
organization. Such measures may be
quantitative, or the size of a risk
adjustment may be set judgmentally,
subject to appropriate oversight.
Æ Deferral of Payment: The actual
payout of an award to an employee is
delayed significantly beyond the end of
the performance period, and the
amounts paid are adjusted for actual
losses or other aspects of performance
that become clear only during the
deferral period.12 Deferred payouts may
be altered according to risk outcomes
either formulaically or judgmentally,
though extensive use of judgment might
make it more difficult to execute
deferral arrangements in a sufficiently
predictable fashion to influence
employee behavior. To be most
effective, the deferral period should be
12 The deferral of payment method is sometimes
referred to in the industry as a ‘‘clawback.’’ The
term ‘‘clawback’’ also may refer specifically to an
arrangement under which an employee must return
incentive compensation payments previously
received by the employee (and not just deferred) if
certain risk outcomes occur. Section 304 of the
Sarbanes-Oxley Act of 2002 (15 U.S.C. 7243), which
applies to chief executive officers and chief
financial officers of public banking organizations, is
an example of this more specific type of ‘‘clawback’’
requirement.

E:\FR\FM\27OCN1.SGM

27OCN1

55234

Federal Register / Vol. 74, No. 206 / Tuesday, October 27, 2009 / Notices

pwalker on DSK8KYBLC1PROD with NOTICES

sufficiently long to allow for the
realization of a substantial portion of the
risks from employee activities, and the
measures of loss should be clearly
explained to employees and closely tied
to their activities during the relevant
performance period.
Æ Longer Performance Periods: The
time period covered by the performance
measures used in determining an
employee’s award is extended (for
example, from one year to two years).
Longer performance periods and
deferral of payment are related in that
both methods allow awards or payments
to be made after some or all risk
outcomes are realized or better known.
Æ Reduced Sensitivity to Short-Term
Performance: The banking organization
reduces the rate at which awards
increase as an employee achieves higher
levels of the relevant performance
measure(s). Rather than offsetting risktaking incentives associated with the
use of short-term performance measures,
this method reduces the magnitude of
such incentives.13
These methods for achieving balance
are not exclusive, and additional
methods or variations may exist or be
developed. Moreover, each method has
its own advantages and disadvantages.
For example, where reliable risk
measures exist, risk adjustment of
awards may be more effective than
deferral of payment in reducing
incentives for excessive risk-taking. This
is because risk adjustment potentially
can take account of the full range and
time horizon of risks, rather than just
those risk outcomes that occur or
become evident during the deferral
period. On the other hand, deferral of
payment may be more effective than risk
adjustment in mitigating incentives to
take hard-to-measure risks (such as the
risks of new activities or products),
particularly if such risks are likely to be
realized during the deferral period.
Accordingly, in some cases two or more
methods may be needed in combination
for an incentive compensation
arrangement to be balanced. The greater
the potential incentives an arrangement
creates for an employee to increase the
risks borne by the organization, the
stronger the effect should be of the
methods applied to achieve balance.
Methods and practices for making
compensation sensitive to risk-taking
13 Performance targets may have a material effect
on risk-taking incentives. Such targets may offer
employees greater rewards for increments of
performance that are above the target or may
provide that awards will be granted only if a target
is met or exceeded. Employees may be particularly
motivated to take excessive risk in order to reach
performance targets that are aggressive, but
potentially achievable.

VerDate Nov<24>2008

16:45 Oct 26, 2009

Jkt 220001

are likely to evolve rapidly during the
next few years, driven in part by the
efforts of supervisors and other
stakeholders. A banking organization
should monitor developments in the
field and should incorporate new or
emerging methods or practices that are
likely to improve the organization’s
safety and soundness into its incentive
compensation systems.
• The manner in which a banking
organization seeks to achieve balanced
incentive compensation arrangements
should be tailored to account for the
differences between employees—
including the substantial differences
between senior executives and other
employees—as well as between banking
organizations.
Activities and risks may vary
significantly both across banking
organizations and across employees
within a particular banking
organization. For example, the risks
associated with the activities of one
group of non-executive employees (e.g.,
loan originators) may differ significantly
from those of another group of nonexecutive employees (e.g., spot foreign
exchange traders). In addition, reliable
quantitative measures of risk and risk
outcomes are unlikely to be available for
a banking organization as a whole,
particularly a large complex
organization. This can make it difficult
for banking organizations to achieve
balanced compensation arrangements
for senior executives who have
responsibility for managing risks on a
firm-wide basis through use of the risk
adjustment of award method.
Moreover, the payment of deferred
incentive compensation in equity (such
as restricted stock of the organization) or
equity-based instruments (such as
options to acquire the organization’s
stock) may be effective in restraining the
risk-taking incentives of senior
executives and other employees whose
activities may have a material effect on
the overall financial performance of the
firm. However, equity-related deferred
compensation may not be as effective in
restraining the incentives of lower-level
employees (particularly at large
organizations) to take risks because such
employees are unlikely to believe that
their actions will materially affect the
organization’s stock price.
Banking organizations should take
account of these differences when
constructing balanced compensation
arrangements. For most banking
organizations, the use of a single,
formulaic approach to making employee
incentive compensation arrangements
appropriately risk-sensitive is likely to

PO 00000

Frm 00054

Fmt 4703

Sfmt 4703

provide at least some employees with
incentives to take excessive risks.14
Incentive compensation arrangements
for senior executives at LCBOs are likely
to be better balanced if they involve
deferral of a substantial portion of the
executives’ incentive compensation over
a multi-year period in a way that
reduces the amount received in the
event of poor performance, substantial
use of multi-year performance periods,
or both. Similarly, the compensation
arrangements for senior executives at
LCBOs are likely to be better balanced
if a significant portion of the incentive
compensation of these executives is
paid in the form of equity-based
instruments that vest over multiple
years, with the number of instruments
ultimately received dependent on the
performance of the firm during the
deferral period. The portion of the
incentive compensation of other
employees that is deferred or paid in the
form of equity-based instruments should
appropriately take into account the
level, nature, and duration of the risks
that the employees’ activities create for
the organization and the extent to which
those activities may materially affect the
overall performance of the firm and its
stock price.
• Banking organizations should
carefully consider the potential for
‘‘golden parachutes’’ and the vesting
arrangements for deferred compensation
to affect the risk-taking behavior of
employees while at the organizations.
Arrangements that provide for an
employee (typically a senior executive),
upon departure from the organization or
a change in control of the organization,
to receive large additional payments or
the accelerated payment of deferred
amounts without regard to risk or risk
outcomes, can provide the employee
significant incentives to engage in
undue risk-taking. Banking
organizations should carefully review
any such existing or proposed
arrangements (sometimes called ‘‘golden
parachutes’’) and the potential impact of
such arrangements on the organization’s
safety and soundness. A banking
organization should ensure that golden
parachute arrangements do not
encourage excessive risk-taking in light
of the other features of the employee’s
incentive compensation arrangements.
Similarly, provisions that require an
employee to forfeit deferred incentive
compensation payments upon departure
from the organization may weaken the
14 For example, spreading payouts of incentive
compensation awards over a three-year period may
not be sufficient by itself to balance the
compensation arrangements of employees who may
expose the organization to substantial longer-term
risks.

E:\FR\FM\27OCN1.SGM

27OCN1

pwalker on DSK8KYBLC1PROD with NOTICES

Federal Register / Vol. 74, No. 206 / Tuesday, October 27, 2009 / Notices
effectiveness of the deferral arrangement
in achieving balance by removing the
employee’s financial exposure to the
risk outcomes of the employee’s
activities at the firm. This weakening
effect can be particularly significant for
senior executives or other skilled
individuals whose services are in high
demand within the market. In such
circumstances, the departing employee
often may be able to negotiate a ‘‘golden
handshake’’ arrangement with the
employee’s new firm, which
compensates the employee for some or
all of the estimated, non-risk-adjusted
value of the deferred incentive
compensation forfeited by the employee
upon departure from the organization.
While a banking organization may not
be able to control the hiring practices of
other firms, it should consider whether
golden handshake arrangements are
materially weakening the organization’s
efforts to constrain the risk-taking
incentives of employees and, if so,
whether changes to the organization’s
deferred compensation vesting policies
or other aspects of its incentive
compensation arrangements should be
made to ensure that they do not
encourage employees to take excessive
risks while employed by the
organization.
• Banking organizations should
effectively communicate to employees
the ways in which incentive
compensation awards and payments
will be reduced as risks increase.
In order for the risk-sensitive
provisions of incentive compensation
arrangements to affect employee risktaking behavior, the organization’s
employees must understand that the
amount of incentive compensation that
they may receive will vary based on the
risk associated with their activities.
Accordingly, banking organizations
should ensure that the employees
covered by an incentive compensation
arrangement are informed about the key
ways in which risks are taken into
account in determining the amount of
incentive compensation paid. Where
feasible, an organization’s
communications with employees should
include examples of how incentive
compensation payments may be
adjusted to reflect projected or actual
risk-outcomes. An organization’s
communications should be tailored
appropriately to reflect the
sophistication of the relevant
audience(s).
Principle 2: Compatibility With
Effective Controls and Risk Management
A banking organization’s riskmanagement processes and internal
controls should reinforce and support

VerDate Nov<24>2008

16:45 Oct 26, 2009

Jkt 220001

the development and maintenance of
balanced incentive compensation
arrangements.
• Banking organizations should have
appropriate controls to ensure that their
processes for achieving balanced
compensation arrangements are
followed and to maintain the integrity of
their risk management and other
functions.
In order to increase their own
compensation, employees may seek to
evade the processes established by a
banking organization to achieve
balanced compensation arrangements.
Similarly, an employee covered by an
incentive compensation arrangement
may seek to influence the risk measures
or other information or judgments that
are used to make the employee’s pay
sensitive to risk in ways designed to
increase the employee’s pay.
If successful, these actions may
significantly weaken the effectiveness of
an organization’s incentive
compensation arrangements in
restricting excessive risk-taking. These
actions can have a particularly
damaging effect on the safety and
soundness of the organization if they
result in the weakening of risk
measures, information, or judgments
that the organization uses for other risk
management, internal control, or
financial purposes. In such cases, the
employee’s actions may weaken not
only the balance of the organization’s
incentive compensation arrangements,
but also the risk management, internal
controls, and other functions that are
supposed to act as a separate check on
risk-taking.
To help prevent this damage from
occurring, a banking organization
should have strong controls governing
its process for designing, implementing,
and monitoring incentive compensation
arrangements. For example, an
organization’s policies and procedures
should (i) identify and describe the
role(s) of the personnel, business units,
and control units authorized to be
involved in the design, implementation,
and monitoring of incentive
compensation arrangements; (ii) identify
the source of significant risk-related
inputs into these processes and
establish appropriate controls governing
the development and approval of these
inputs to help ensure their integrity; and
(iii) identify the individual(s) and
control unit(s) whose approval is
necessary for the establishment of new
incentive compensation arrangements or
modification of existing arrangements.
Banking organizations also should
create and maintain sufficient
documentation to permit an audit of the
organization’s processes for

PO 00000

Frm 00055

Fmt 4703

Sfmt 4703

55235

establishing, modifying, and monitoring
incentive compensation arrangements.
A banking organization should
conduct regular internal reviews to
ensure that its processes for achieving
and maintaining balanced incentive
compensation arrangements are
consistently followed. Such reviews
should be conducted by audit,
compliance, or other personnel in a
manner consistent with the
organization’s overall framework for
compliance monitoring. An
organization’s internal audit department
also should separately conduct regular
audits of the organization’s compliance
with its established policies and
controls relating to incentive
compensation arrangements. The results
should be reported to appropriate levels
of management and, where appropriate,
the organization’s board of directors.
Reviews conducted by regional or
community banking organizations
should be tailored to the management,
internal control, compliance, and audit
framework for the organization, as well
as the scope and complexity of the
organization’s activities and its use of
incentive compensation arrangements.
• Appropriate personnel, including
risk-management personnel, should
have input into the organization’s
processes for designing incentive
compensation arrangements and
assessing their effectiveness in
restraining excessive risk-taking.
Developing balanced compensation
arrangements and monitoring
arrangements to ensure they achieve
balance over time requires an
understanding of the risks (including
compliance risks) and potential risk
outcomes associated with the activities
of the relevant employees. Accordingly,
banking organizations should have
policies and procedures that ensure that
risk-management personnel have an
appropriate role in the organization’s
processes for designing incentive
compensation arrangements and for
assessing their effectiveness in
restraining excessive risk-taking.15 Ways
that risk managers might assist in
achieving balanced compensation
arrangements include, but are not
limited to (i) reviewing the types of risks
associated with the activities of
employees covered by an incentive
compensation arrangement; (ii)
approving the risk measures used in risk
adjustments and performance measures,
as well as measures of risk outcomes
15 Involvement of risk-management personnel in
the design and monitoring of these arrangements
also should help ensure that the organization’s riskmanagement functions can properly understand
and address the full range of risks facing the
organization.

E:\FR\FM\27OCN1.SGM

27OCN1

pwalker on DSK8KYBLC1PROD with NOTICES

55236

Federal Register / Vol. 74, No. 206 / Tuesday, October 27, 2009 / Notices

used in deferred-payout arrangements;
and (iii) analyzing risk-taking and risk
outcomes relative to incentive
compensation payments.
Other functions within an
organization, such as its control, human
resources, or finance functions, also
play an important role in helping ensure
that incentive compensation
arrangements are balanced. For
example, these functions may contribute
to the design and review of performance
measures used in compensation
arrangements or may supply data used
as part of these measures.
• Compensation for employees in risk
management and control functions
should be sufficient to attract and retain
qualified personnel and should avoid
conflicts of interest.
The risk management and control
personnel involved in the design and
oversight of incentive compensation
arrangements should have appropriate
skills and experience needed to
effectively fulfill their roles, even when
their efforts are challenged by
employees seeking to increase their
incentive compensation in ways that are
inconsistent with sound risk
management or internal controls. The
compensation arrangements for
employees in risk management and
control functions thus should be
sufficient to attract and retain qualified
personnel with appropriate experience
and expertise in these fields. In
addition, to help preserve the
independence of their perspectives, the
incentive compensation received by risk
management and control personnel staff
should not be based predominately on
the financial performance of the
business units that they review. Rather,
the performance measures used in the
incentive compensation arrangements
for these personnel should be based
primarily on the achievement of the
objectives of their functions (e.g., riskadjusted performance or adherence to
internal controls).
• Banking organizations should
monitor the performance of their
incentive compensation arrangements
and should revise the arrangements as
needed if payments do not
appropriately reflect risk.
Banking organizations should track
incentive compensation awards and
payments, risks taken, and actual risk
outcomes to determine whether
incentive compensation payments to
employees are reduced to reflect adverse
risk outcomes. Results should be
reported to appropriate levels of
management, including where
warranted, the board of directors. A
banking organization should take the
results of such monitoring into account

VerDate Nov<24>2008

16:45 Oct 26, 2009

Jkt 220001

in establishing or modifying incentive
compensation arrangements and in
overseeing associated controls. If, over
time, incentive compensation paid by a
banking organization does not
appropriately reflect risk outcomes, the
organization should review and revise
its incentive compensation
arrangements and related controls to
ensure that the arrangements, as
designed and implemented, are
balanced and do not provide employees
incentives to take excessive risks.
Principle 3: Strong Corporate
Governance
Banking organizations should have
strong and effective corporate
governance to help ensure sound
compensation practices.
• The board of directors of a banking
organization should actively oversee
incentive compensation arrangements.
The board of directors of an
organization is ultimately responsible
for ensuring that the organization’s
incentive compensation arrangements
are appropriately balanced and do not
jeopardize the safety and soundness of
the organization. Accordingly, the board
of directors should actively oversee the
development and operation of a banking
organization’s incentive compensation
systems and related control processes.16
For example, the board of directors
should review and approve the overall
goals and purposes of the firm’s
incentive compensation system. The
board should provide clear direction to
management to ensure that its policies
and procedures are carried out in a
manner that achieves balance and is
consistent with safety and soundness.
In addition, the board of directors
should ensure that the compensation
system—including performance
measures and targets—for business units
and individual employees that can
expose the firm to large amounts of risk
is designed and operated in a manner
that will achieve balance. Given the key
role of senior executives in managing
the overall risk-taking activities of an
organization, the board of directors
should directly approve the incentive
compensation arrangements for senior
executives. The board should approve
and document any material exceptions
or adjustments to the incentive
compensation arrangements established
16 As used in this guidance, the term ‘‘board of
directors’’ is used to refer to the members of the
board of directors who have primary responsibility
for overseeing the incentive compensation system.
Depending on the manner in which the board is
organized, the term may refer to the entire board of
directors, a compensation committee of the board,
or another committee of the board that has primary
responsibility for overseeing the incentive
compensation system.

PO 00000

Frm 00056

Fmt 4703

Sfmt 4703

for senior executives and should
carefully consider and monitor the
effects of any approved exceptions or
adjustments on the balance of the
arrangement, the risk-taking incentives
of the senior executive, and the safety
and soundness of the organization.
• The board of directors should
monitor the performance, and regularly
review the design and function, of
incentive compensation arrangements.
The board of directors should
regularly review the design and monitor
the performance of the organization’s
incentive compensation systems. To
allow for informed reviews, the board
should receive data and analysis from
management or other sources that are
sufficient to allow the board to assess
whether the overall design and
performance of the organization’s
incentive compensation arrangements
are consistent with the organization’s
safety and soundness. For example, the
board should receive and review, on an
annual or more frequent basis, an
assessment by management, with
appropriate input from riskmanagement personnel, of the
effectiveness of the design and
operation of the organization’s incentive
compensation system in providing risktaking incentives that are consistent
with the organization’s safety and
soundness. These reports should
include an evaluation of whether or
how incentive compensation practices
may be encouraging excessive risktaking. These reviews and reports
should be appropriately scoped to
reflect the size and complexity of the
banking organization’s activities and the
prevalence and scope of its incentive
compensation arrangements.
In addition, at banking organizations
that are significant users of incentive
compensation arrangements, the board
should receive periodic reports that
review incentive compensation awards
and payments relative to risk outcomes
on a backward-looking basis to
determine whether the organization’s
incentive compensation arrangements
may be promoting excessive risk-taking.
Boards of directors of these
organizations also should consider
periodically obtaining and reviewing
scenario analysis of compensation on a
forward-looking basis based on a range
of performance levels, risk outcomes,
and the amount of risks taken.
The board should closely monitor
incentive compensation payments to
senior executives and their sensitivity to
risk outcomes. This monitoring should
include the review of both backwardlooking and forward-looking scenario
analysis for senior executives separate
from other employees. In addition, if the

E:\FR\FM\27OCN1.SGM

27OCN1

pwalker on DSK8KYBLC1PROD with NOTICES

Federal Register / Vol. 74, No. 206 / Tuesday, October 27, 2009 / Notices
compensation arrangement for a senior
executive includes a clawback
provision, then the review should
include sufficient information to
determine if the provision has been
triggered.
The board of directors should seek to
stay abreast of significant emerging
changes in compensation plan
mechanisms and incentives in the
marketplace. However, the board should
recognize that institutions, activities,
and practices within the industry are
not identical. Incentive compensation
arrangements at one firm may not be
suitable for use at another firm because
of differences in the risks, controls,
structure, and management among
firms. The board of directors of each
organization is responsible for ensuring
that the incentive compensation
arrangements for its organization do not
encourage employees to take risks that
are beyond the firm’s ability to manage
effectively, regardless of the practices
employed by other firms.
• The organization, composition, and
resources of the board of directors
should permit effective oversight of
incentive compensation.
If a separate compensation committee
is not already in place or required by
other authorities,17 the board of
directors should consider establishing
such a committee—reporting to the full
board—that has primary responsibility
for overseeing the organization’s
incentive compensation systems. A
compensation committee should be
composed solely or predominantly of
non-executive directors. If the board
does not have such a compensation
committee, the board should take other
steps to ensure that non-executive
directors of the board are actively
involved in the oversight of incentive
compensation systems. At LCBOs and
large regional banking organizations,
and at other banking organizations
where feasible, one or more of the board
of directors should have a level of
expertise and experience in risk
management and compensation
practices in the financial services
industry that is appropriate for the
nature, scope, and complexity of the
organization’s activities. The
compensation committee should work
closely with any board-level risk and
audit committees where the substance
of their activities overlap.
The board of directors should have
the authority to, where appropriate,
select, compensate, and use outside
counsel, consultants, or other experts
17 See NYSE Listed Company Manual Section
303A.05(a); Nasdaq Listing Rule 5605(d); Internal
Revenue Code section 162(m) (26 U.S.C. 162(m)).

VerDate Nov<24>2008

16:45 Oct 26, 2009

Jkt 220001

with expertise in incentive
compensation and risk management.18
In selecting and using outside parties,
the board of directors should give due
attention to potential conflicts of
interest arising from other dealings of
the parties with the firm or for other
reasons. The board also should exercise
caution to avoid allowing outside
parties to obtain undue levels of
influence. While the retention and use
of outside parties may be helpful, the
board retains ultimate responsibility for
ensuring that the organization’s
incentive compensation arrangements
are consistent with safety and
soundness.
• A banking organization’s disclosure
practices should support safe and sound
incentive compensation arrangements.
If a banking organization’s incentive
compensation arrangements provide
employees incentives to take risks that
are beyond the tolerance of the
organization’s shareholders, these risks
are likely to also present a risk to the
safety and soundness of the
organization.19 To help promote safety
and soundness, a banking organization
should provide an appropriate amount
of information concerning its incentive
compensation arrangements and related
risk management, control, and
governance processes to shareholders to
allow them to monitor and, where
appropriate, take actions to restrain the
potential for such arrangements and
processes to encourage employees to
take excessive risks.
The scope and level of the
information disclosed by the
organization should be tailored to the
nature and complexity of the
organization and its incentive
compensation arrangements. The
Securities and Exchange Commission
(SEC), for example, has proposed to
adopt certain disclosure requirements
relating to incentive compensation
practices for public companies.20 The
Federal Reserve will work with the SEC
to improve the disclosures provided by
public banking organizations in ways
that promote the safety and soundness
of these organizations. In addition, in
18 It is recognized that the board of directors of
an organization with less complex and extensive
incentive compensation arrangements, such as
many smaller regional and community banking
organizations, may not find it necessary or
appropriate to retain and use outside experts in this
area.
19 On the other hand, as noted previously,
compensation arrangements that are in the interests
of the shareholders of a banking organization are
not necessarily consistent with safety and
soundness. This is because the federal safety net
bears some of the downside of risks taken by
organizations with access, directly or through a
subsidiary, to the safety net.
20 See 74 FR 35076, July 17, 2009.

PO 00000

Frm 00057

Fmt 4703

Sfmt 4703

55237

connection with the special horizontal
review process, the Federal Reserve will
conduct a review of its regulatory
reporting forms to determine what
type(s) of summary-level quantitative
information concerning incentive
compensation arrangements, awards,
and payments would be appropriate for
the Federal Reserve to collect and make
publicly available to help promote
balanced incentive compensation
arrangements.
• Large, complex banking
organizations should follow a
systematic approach to developing a
compensation system that has balanced
incentive compensation arrangements.
At banking organizations with large
numbers of risk-taking employees
engaged in diverse activities, an ad hoc
approach to developing balanced
arrangements is unlikely to be reliable.
Thus, an LCBO should use a systematic
approach—supported by robust and
formalized policies, procedures, and
systems—to ensure that those
arrangements are appropriately
balanced and consistent with safety and
soundness. Such an approach should
provide for the organization effectively
to:
• Identify employees who are eligible
to receive incentive compensation and
whose activities may expose the
organization to material risks. These
employees should include (i) senior
executives and others who are
responsible for oversight of the
organization’s firm-wide activities or
material business lines; (ii) individual
employees, including non-executive
employees, whose activities may expose
the firm to material amounts of risk; and
(iii) groups of employees who are
subject to the same or similar incentive
compensation arrangements and who, in
the aggregate, may expose the firm to
material amounts of risk;
• Identify the types and time horizons
of risks to the organization from the
activities of these employees;
• Assess the potential for the
performance measures included in the
incentive compensation arrangements
for these employees to encourage the
employees to take excessive risks;
• Include measures, such as risk
adjustments or deferral periods, within
the incentive compensation
arrangements for these employees that
are reasonably designed to ensure that
the arrangement will be balanced;
• Communicate to the employees the
ways in which their incentive
compensation awards or payments will
be adjusted to reflect the risks of their
activities to the organization; and
• Monitor incentive compensation
awards, payments, risks taken, and risk

E:\FR\FM\27OCN1.SGM

27OCN1

55238

Federal Register / Vol. 74, No. 206 / Tuesday, October 27, 2009 / Notices

pwalker on DSK8KYBLC1PROD with NOTICES

outcomes for these employees and
modify the relevant arrangements if
payments made are not appropriately
sensitive to risk and risk outcomes.
Regional and community banking
organizations should develop and
implement appropriate policies,
procedures, and systems in a manner
that is tailored to the size and
complexity of the organization’s
activities, as well as the prevalence and
scope of its incentive compensation
arrangements.
III. Supervisory Initiatives
As noted earlier, the Federal Reserve
is commencing two supervisory
initiatives in order to spur and monitor
the industry’s progress toward the
implementation of safe and sound
incentive compensation arrangements,
identify emerging best practices, and
advance the state of practice more
generally in the industry. In addition,
the Federal Reserve will, on an on-going
basis, assess banking organizations’
incentive compensation arrangements
for conformity with the principles of
safety and soundness outlined in this
guidance.
Large, complex banking
organizations. LCBOs warrant the most
intensive supervisory attention in the
short run because they are significant
users of incentive compensation
arrangements and because the adverse
effects of flawed approaches at these
institutions are more likely to have
adverse effects on the broader financial
system. Accordingly, the Federal
Reserve will conduct a formal
horizontal review of incentive
compensation arrangements at these
organizations. The review is designed to
achieve the following objectives:
1. Enhance supervisory understanding
of the details of current practices, as
well as the steps taken or proposed to
be taken by organizations to improve the
balance of incentive compensation
arrangements;
2. Assess the strength of controls and
whether actual payouts under incentive
compensation arrangements are
effectively monitored relative to actual
risk outcomes;
3. Understand the role played by
boards of directors, compensation
committees, and risk-management
functions in designing, approving, and
monitoring incentive compensation
systems; and
4. Identify emerging best practices
through comparison of practices across
organizations and business lines.
As part of this review, each LCBO will
be expected to provide the Federal
Reserve information and documentation
that clearly describes (i) the structure of

VerDate Nov<24>2008

16:45 Oct 26, 2009

Jkt 220001

the organization’s current incentive
compensation arrangements, (ii) the
existing processes used by the
organization to oversee these
arrangements and help ensure that they
do not encourage employees to take
excessive risks, and (iii) the
organization’s plans, including relevant
timetables, for improving the risksensitivity of incentive compensation
arrangements and related risk
management, controls, and corporate
governance practices.
The Federal Reserve will work closely
with each LCBO to ensure that its plans
are likely to result in the establishment
and maintenance of incentive
compensation arrangements that are
consistent with safety and soundness
and do not encourage excessive risktaking. In addition, the Federal Reserve
will closely monitor actions taken by
the organization under the plan,
including the organization’s adherence
to timetables set forth in its plan for
improvements to be developed and
implemented. As noted earlier, the
Federal Reserve may take supervisory
action as appropriate if the organization
fails to develop, submit, or adhere to an
effective plan designed to ensure that
the organization’s incentive
compensation arrangements do not
encourage excessive risk-taking and are
consistent with principles of safety and
soundness. Such action may include the
establishment of appropriate limitations
on the organization’s incentive
compensation awards or payments to
help ensure that the organization’s
incentive compensation arrangements
do not pose a threat to the safety and
soundness of the organization.
Community and regional banking
organizations with incentive
compensation arrangements.
Supervisory staff should review
incentive compensation arrangements at
non-LCBO banking organizations as part
of the regular, risk-focused supervisory
process.21 These reviews should be
conducted in connection with the
review of the organization’s risk
management, internal controls and
corporate governance, and should be
tailored to reflect the scope and
complexity of the organization’s
activities and prevalence and scope of
its incentive compensation
arrangements. Thus, for example, a
small banking organization that uses

incentive compensation arrangements
on a limited basis is not expected to
have as formalized, extensive, and
detailed policies, procedures, and
systems governing its incentive
compensation arrangements as a LCBO
that uses incentive compensation
arrangements extensively. In addition,
in considering the potential for
incentive compensation arrangements,
including commission-based programs,
to encourage excessive risk-taking,
examiners should take into account the
strength of the organization’s risk
management and internal control
framework in managing and controlling
risks.
If examiners find incentive
compensation practices that may be of
concern, examiners should consult with
the multidisciplinary group described
previously. The Federal Reserve will
incorporate the findings of these
reviews into the organization’s
supervisory ratings and, where
warranted, may take supervisory action
against the organization to address
deficiencies.

21 Thus, for example, reviews at bank holding
companies with total consolidated assets of $5
billion or less will be conducted in accordance with
the risk-focused supervision program for these
organizations. See SR letter 02–1, Revisions to Bank
Holding Company Supervision Procedures for
Organizations with Total Consolidated Assets of $5
Billion or Less (Jan. 9, 2002).

By order of the Board of Governors of the
Federal Reserve System, October 22, 2009.
Robert deV. Frierson,
Deputy Secretary of the Board.
[FR Doc. E9–25766 Filed 10–26–09; 8:45 am]

PO 00000

Frm 00058

Fmt 4703

Sfmt 4703

IV. Conclusion
Banking organizations are responsible
for ensuring that their incentive
compensation arrangements do not
encourage excessive risk-taking and do
not pose a threat to the safety and
soundness of the organization. The
Federal Reserve expects banking
organizations to take prompt action to
address deficiencies in their incentive
compensation arrangements or related
risk management, control, and
governance processes.
The Federal Reserve expects to
actively monitor the actions taken by
banking organizations in this area and
will promote further advances in
designing and implementing balanced
incentive compensation arrangements.
Where appropriate, the Federal Reserve
will take supervisory or enforcement
action to ensure that material
deficiencies that pose a threat to the
safety and soundness of the organization
are promptly addressed. The Federal
Reserve also will update this guidance
as appropriate to incorporate best
practices as they develop over time.
This concludes the text of the
proposed guidance.

BILLING CODE 6210–01–P

E:\FR\FM\27OCN1.SGM

27OCN1