[Federal Register Volume 75, Number 11 (Tuesday, January 19, 2010)]
[Proposed Rules]
[Pages 2823-2826]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2010-718]


=======================================================================
-----------------------------------------------------------------------

FEDERAL DEPOSIT INSURANCE CORPORATION

12 CFR Part 327

RIN 3064-AD56


Incorporating Employee Compensation Criteria Into the Risk 
Assessment System

AGENCY: Federal Deposit Insurance Corporation (FDIC).

ACTION: Advance notice of proposed rulemaking (ANPR).

-----------------------------------------------------------------------

SUMMARY: The FDIC is seeking comment on ways that the FDIC's risk-based 
deposit insurance assessment system (risk-based assessment system) 
could be changed to account for the risks posed by certain employee 
compensation programs. Section 7 of the Federal Deposit Insurance Act 
(FDI Act) sets forth the risk-based assessment authorities underlying 
the FDIC's deposit insurance system. The FDIC seeks comment on all 
aspects of this ANPR.

DATES: Comments must be submitted on or before February 18, 2010.

ADDRESSES: You may submit comments on the advance notice of proposed 
rulemaking by any of the following methods:
     Agency Web Site: http://www.FDIC.gov/regulations/laws/federal/propose.html. Follow the instructions for submitting comments 
on the Agency Web Site.
     E-mail: [email protected]. Include RIN 3064-AD56 
on the subject line of the message.
     Mail: Robert E. Feldman, Executive Secretary, Attention: 
Comments, Federal Deposit Insurance Corporation, 550 17th Street, NW., 
Washington, DC 20429.
     Hand Delivery: Comments may be hand delivered to the guard 
station at the rear of the 550 17th Street Building (located on F 
Street) on business days between 7 a.m. and 5 p.m.
    Instructions: All comments received will be posted generally 
without change to http://www.fdic.gov/regulations/laws/federal/
propose.html, including any personal information provided.

[[Page 2824]]


FOR FURTHER INFORMATION CONTACT: Marc Steckel, Associate Director, 
(202) 898-3618, Rose Kushmeider, Acting Section Chief, (202) 898-3861, 
Daniel Lonergan, Counsel, (202) 898-6971, or Sheikha Kapoor, Senior 
Attorney, (202) 898-3960.

SUPPLEMENTARY INFORMATION:

I. Background

    Section 7 of the FDI Act requires the FDIC to establish a risk-
based assessment system that incorporates statutory and other factors 
determined to be relevant in assessing the probability that the Deposit 
Insurance Fund (DIF) will incur a loss from the failure of an insured 
depository institution. In accordance with this mandate, the FDIC is 
exploring whether and, if so, how to incorporate employee compensation 
criteria into the risk-based assessment system. The FDIC does not seek 
to limit the amount which employees are compensated, but rather is 
concerned with adjusting risk-based deposit insurance assessment rates 
(risk-based assessment rates) to adequately compensate the DIF for the 
risks inherent in the design of certain compensation programs. By doing 
this, the FDIC seeks to provide incentives for institutions to adopt 
compensation programs that align employees' interests with the long-
term interests of the firm and its stakeholders, including the FDIC. 
Such incentives would also seek to promote the use of compensation 
programs that reward employees for internalizing the firm's focus on 
risk management.
    This initiative is intended to be a complementary effort to the 
supervisory standards being developed both domestically and 
internationally to address the risks posed by poorly designed 
compensation programs. While supervisory standards are set to define 
the minimum standards that all institutions must meet, the FDIC seeks 
to use the deposit insurance assessment system to provide incentives 
for institutions to meet higher standards, should they choose to do so. 
Using the deposit insurance assessment system in this way does not 
mandate institutions to adopt higher standards, but instead would 
broaden and improve the regulatory approach to addressing compensation 
issues by providing institutions with an incentive to choose to exceed 
base supervisory standards.
    In the wake of the global financial crisis that began in 2007, 
public, academic, and government attention has been directed toward the 
compensation practices of financial institutions--especially the 
largest, most complex, financial organizations--with particular focus 
on whether compensation practices contributed to the excessive build-up 
of risk that precipitated the crisis. A review of work by academics, 
consulting groups and others indicates a broad consensus that some 
compensation structures misalign incentives and induce imprudent risk 
taking within financial organizations.\1\ Some poorly designed 
compensation structures reward employees based on short-term results 
without full consideration of the longer-term risks to the firm. In so 
doing, they fail to align individual incentives with those of the 
firm's other stakeholders, including shareholders and the FDIC.
---------------------------------------------------------------------------

    \1\  See, e.g., Lucian Bebchuk, Alma Cohen, and Holger Spamann, 
``The Wages of Failure: Executive Compensation at Bear Stearns and 
Lehman 2000-2008,'' Yale Journal on Regulation (forthcoming) (http://www.law.harvard.edu/faculty/bebchuk/pdfs/BCS-Wages-of-Failure-Nov09.pdf); Carl R. Chen, Thomas L. Steiner, and Ann Marie Whyte, 
``Does Stock Option-Based Executive Compensation Induce Risk-Taking? 
An Analysis of the Banking Industry,'' Journal of Banking & Finance, 
30, pp. 915-945 (2006); Alon Raviv and Yoram Landskroner, ``The 
2007-2009 Financial Crisis and Executive Compensation: Analysis and 
a Proposal for a Novel Structure,'' (NYU finance working paper) 
(http://archive.nyu.edu/handle/2451/28105); Jonathan R. Macey and 
Maureen O'Hara, ``Corporate Governance of Banks,'' FRBNY Economic 
Policy Review, 9, pp. 91-107 (2003); and Valentine V. Craig, ``The 
Changing Corporate Governance Environment: Implications for the 
Banking Industry,'' FDIC Banking Review, 16, pp. 121-135 (2004). In 
addition, the Federal banking agencies addressed compensation in the 
Interagency Statement on Meeting the Needs of Creditworthy 
Borrowers, issued November 12, 2008. Specifically, this interagency 
statement notes that poorly designed management compensation 
policies can ``create perverse incentives'' that may jeopardize the 
institution's health.
---------------------------------------------------------------------------

    Excessive and imprudent risk taking remains a contributing factor 
in financial institution failures and losses to the DIF, and to some 
extent these losses can be attributed to the incentives provided by 
poorly designed compensation programs. Section 7 of the FDI Act 
requires the FDIC to account for these risks to the DIF when setting 
risk-based assessment rates. This ANPR seeks comment on a variety of 
issues that will be considered in this effort.
    While there is general agreement that certain compensation programs 
misalign incentives and increase risk, the proposals to address these 
problems differ. In sum, identifying the risks posed is easier than 
identifying the most appropriate solution to address them. 
Recommendations include mandated stock purchases, performance look-back 
periods, and bonus clawbacks. Other recommendations focus on the 
benefits of improving the effectiveness of compensation committees, or 
on the benefits of shareholders' ``say-on-pay.''

Legal Framework

    Section 7 of the Federal Deposit Insurance Act (FDI Act, 12 U.S.C. 
1817) sets forth the risk-based assessment authorities underlying the 
FDIC's deposit insurance system. It requires that a depository 
institution's deposit insurance assessment be based on the probability 
that the DIF will incur a loss with respect to that institution, the 
likely amount of the loss, and the revenue needs of the DIF. 12 U.S.C. 
1817(b)(1)(C). Employee compensation programs have been cited as a 
contributing factor in 35 percent of the reports prepared in 2009 
investigating the causes of insured depository institution failures and 
the associated losses to the DIF.
    The FDIC's Board of Directors is required to set risk-based 
assessments for insured depository institutions in such amounts as it 
determines to be necessary or appropriate. 12 U.S.C. 1817(b)(2)(A). The 
Board of Directors must, in setting risk-based assessments, consider 
the estimated operating expenses of the DIF, the estimated case 
resolution expenses and income of the DIF, the projected effects of the 
payment of assessments on the capital and earnings of insured 
depository institutions, the risk factors listed at 12 U.S.C. 
1817(b)(1)(C), and any other factors the Board determines to be 
appropriate. 12 U.S.C. 1817(b)(2)(B). The FDIC believes the risks 
presented by certain employee compensation programs are an appropriate 
factor for the Board to consider when setting risk-based assessments.
    In some cases, an institution's risk profile can be affected by 
holding company and affiliate activities. For example, employees of a 
parent holding company may be responsible for making decisions or 
taking actions that will have a material effect on the insured 
depository institution. In this scenario, the control of significant 
risks affecting the insured depository institution resides outside the 
institution, but in the event of failure, the costs associated with the 
risk will be borne by the DIF. In another example, an employee may have 
dual responsibilities--to the insured depository institution and to the 
parent holding company or affiliate--and thus be partly compensated 
under a contract with a parent company or affiliate. The FDIC is 
seeking comment on how these types of risks should be accounted for 
when setting an institution's risk-based assessment.
    The Board of Directors may establish separate risk-based assessment 
systems for large and small members of the DIF. 12 U.S.C. 
1817(b)(1)(D). However, no

[[Page 2825]]

insured depository institution may be barred from the lowest-risk 
category solely because of size. 12 U.S.C. 1817(b)(2)(D). Any changes 
made to the risk-based assessment system would be subject to this 
constraint.
    The FDIC views the contemplated changes to the risk-based 
assessment system as separate from and complementary to recent 
supervisory initiatives to address compensation issues. Unlike 
supervisory standards, which set a floor below which the insured 
depository institution cannot operate, the contemplated standards used 
for determining risk-based assessment rates would be voluntary. The 
risk-based assessment system is therefore designed to provide 
incentives for institutions to adopt standards that exceed supervisory 
minimum standards. The existing risk-based assessment system provides a 
variety of incentives for institutions to achieve lower risk-based 
assessment rates by exceeding supervisory minimum standards. The FDIC 
views the contemplated approach as consistent with the existing 
approach whereby the deposit insurance system is used to provide 
incentives for risk management practices that exceed supervisory 
minimum standards, while stopping short of mandating higher standards.

II. Methodology

    Certain compensation programs can increase losses to the DIF as 
they provide incentives for employees of an institution to engage in 
excessive risk taking which can ultimately increase the institution's 
risk of failure. In 2009 there were 49 Material Loss Reviews completed 
that addressed the factors contributing the losses resulting from 
financial institution failures--17 of these reports (35 percent) cited 
employee compensation practices as a contributing factor. Therefore, 
the FDIC is seeking to identify criteria upon which to base adjustments 
to the risk-based assessment system in order to correctly price and 
assess the risks presented by certain compensation programs. These 
criteria would be organized to provide either a ``meets'' or ``does not 
meet'' metric, which would then be used to adjust an institution's 
risk-based assessment rate.

Description of the FDIC's Goals

    The FDIC's goals include:
     Adjusting the FDIC's risk-based assessment rates to 
adequately compensate the DIF for the risks presented by certain 
compensation programs.
     Using the FDIC's risk-based assessment rates to provide 
incentives for insured institutions and their holding companies and 
affiliates to adopt compensation programs that align employees' 
interests with those of the insured depository institution's other 
stakeholders, including the FDIC.
     Promoting the use of compensation programs that reward 
employees for focusing on risk management.
    In assessing institutions for the risks posed by certain 
compensation programs, the FDIC seeks to develop criteria that are 
straightforward and require little additional data to be collected. The 
criteria should allow the FDIC to determine whether an institution has 
adopted a compensation system that either meets a defined standard or 
does not. The FDIC does not seek to impose a ceiling on the level of 
compensation that institutions may pay their employees. Rather, the 
criteria should focus on whether an employee compensation system is 
likely to be successful in aligning employee performance with the long-
term interests of the firm and its stakeholders, including the FDIC. In 
this manner any adjustment to the risk-based assessment system should 
complement supervisory initiatives to ensure that institutions have 
compensation policies that do not encourage excessive risk taking and 
that are consistent with the safety and soundness of the organization.
    Compensation programs that meet the FDIC's goals may include the 
following features:
    1. A significant portion of compensation for employees whose 
business activities can present significant risk to the institution and 
who also receive a portion of their compensation according to formulas 
based on meeting performance goals should be comprised of restricted, 
non-discounted company stock. Such employees would include the 
institution's senior management, among others. Restricted, non-
discounted company stock would be stock that becomes available to the 
employee at intervals over a period of years. Additionally, the stock 
would initially be awarded at the closing price in effect on the day of 
the award.
    2. Significant awards of company stock should only become vested 
over a multi-year period and should be subject to a look-back mechanism 
(e.g., clawback) designed to account for the outcome of risks assumed 
in earlier periods.
    3. The compensation program should be administered by a committee 
of the Board composed of independent directors with input from 
independent compensation professionals.
    Under the approach contemplated above, the FDIC could conclude that 
firms that are able to attest that their compensation programs include 
each of the features listed above present a decreased risk to the DIF, 
and therefore would face a lower risk-based assessment rate than those 
firms that could not make such attestation. Alternatively, the FDIC 
could conclude that firms that cannot attest that their compensation 
programs include each of these features present an increased risk to 
the DIF, and therefore would face a higher risk-based assessment rate 
than those firms that do make such attestation.

III. Request for Comments

    The FDIC requests comment on all aspects of the proposal to 
incorporate employee compensation criteria into the FDIC's risk-based 
assessment system, including comments on the FDIC's stated goals and 
the features of compensation programs that meet such goals. In 
particular, the FDIC invites comment on the following:
    1. Should an adjustment be made to the risk-based assessment rate 
an institution would otherwise be charged if the institution could/
could not attest (subject to verification) that it had a compensation 
system that included the following elements?
    a. A significant portion of compensation for employees whose 
business activities can present significant risk to the institution and 
who also receive a portion of their compensation according to formulas 
based on meeting performance goals would be comprised of restricted, 
non-discounted company stock. The employees affected would include the 
institution's senior management, among others. Restricted, non-
discounted company stock would be stock that becomes available to the 
employee at intervals over a period of years. Additionally, the stock 
would initially be awarded at the closing price in effect on the day of 
the award.
    b. Significant awards of company stock would only become vested 
over a multi-year period and would be subject to a look-back mechanism 
(e.g., clawback) designed to account for the outcome of risks assumed 
in earlier periods.
    c. The compensation program would be administered by a committee of 
the Board composed of independent directors with input from independent 
compensation professionals.
    2. Should the FDIC's risk-based assessment system reward firms 
whose compensation programs present lower

[[Page 2826]]

risk or penalize institutions with programs that present higher risks?
    3. How should the FDIC measure and assess whether an institution's 
board of directors is effectively overseeing the design and 
implementation of the institution's compensation program?
    4. As an alternative to the FDIC's contemplated approach (see q. 
1), should the FDIC consider the use of quantifiable measures of 
compensation--such as ratios of compensation to some specified 
variable--that relate to the institution's health or performance? If 
so, what measure(s) and what variables would be appropriate?
    5. Should the effort to price the risk posed to the DIF by certain 
compensation plans be directed only toward larger institutions; 
institutions that engage only in certain types of activities, such as 
trading; or should it include all insured depository institutions?
    6. How large (that is, how many basis points) would an adjustment 
to the initial risk-based assessment rate of an institution need to be 
in order for the FDIC to have an effective influence on compensation 
practices?
    7. Should the criteria used to adjust the FDIC's risk-based 
assessment rates apply only to the compensation systems of insured 
depository institutions? Under what circumstances should the criteria 
also consider the compensation programs of holding companies and 
affiliates?
    8. How should the FDIC's risk-based assessment system be adjusted 
when an employee is paid by both the insured depository institution and 
its related holding company or affiliate?
    9. Which employees should be subject to the compensation criteria 
that would be used to adjust the FDIC's risk-based assessment rates? 
For example, should the compensation criteria be applicable only to 
executives and those employees who are in a position to place the 
institution at significant risk? If the criteria should only be applied 
to certain employees, how would one identify these employees?
    10. How should compensation be defined?
    11. What mix of current compensation and deferred compensation 
would best align the interests of employees with the long-term risk of 
the firm?
    12. Employee compensation programs commonly provide for bonus 
compensation. Should an adjustment be made to risk-based assessment 
rates if certain bonus compensation practices are followed, such as: 
Awarding guaranteed bonuses; granting bonuses that are greatly 
disproportionate to regular salary; or paying bonuses all-at-once, 
which does not allow for deferral or any later modification?
    13. For the purpose of aligning an employee's interests with those 
of the institution, what would be a reasonable period for deferral of 
the payment of variable or bonus compensation? Is the appropriate 
deferral period a function of the amount of the award or of the 
employee's position within the institution (that is, large bonus awards 
or awards for more senior employees would be subject to greater 
deferral)?
    14. What would be a reasonable vesting period for deferred 
compensation?
    15. Are there other types of employee compensation arrangements 
that would have a greater potential to align the incentives of 
employees with those of the firm's other stakeholders, including the 
FDIC?

Paperwork Reduction Act

    At this stage of the rulemaking process it is difficult to 
determine with precision whether any future regulations will impose 
information collection requirements that are covered by the Paperwork 
Reduction Act (``PRA'') (44 U.S.C. 3501 et seq.). Following the FDIC's 
evaluation of the comments received in response to this ANPR, the FDIC 
expects to develop a more detailed description regarding incorporating 
employee compensation criteria into the risk assessment system, and, if 
appropriate, solicit comment in compliance with PRA.

    Dated at Washington, DC, this 12th day of January 2010.

    By order of the Board of Directors.

Federal Deposit Insurance Corporation.
Robert E. Feldman,
Executive Secretary.
[FR Doc. 2010-718 Filed 1-15-10; 8:45 am]
BILLING CODE 6714-01-P