Federal Reserve Board Issues Proposal Aimed At Incentive Compensation Policies Of Banking Organizations

Author:Mr John Martini, Michael E. Bleier, Jeffrey G. Aromatorio and Randall I. Cherkas
Profession:Reed Smith

On October 22, 2009, the Federal Reserve Board (the "Board") issued supervisory guidance ("Proposed Guidance") designed to ensure that the incentive compensation policies of banking organizations do not undermine the safety and soundness of those organizations. The Proposed Guidance attempts to strengthen supervision of banking organizations. As Board Chairman Ben Bernanke stated, "[c]ompensation practices at some banking organizations have led to misaligned incentives and excessive risk-taking, contributing to bank losses and financial instability." Although the Proposed Guidance is subject to comment until November 27, the Board expects banking organizations to immediately review their incentive compensation arrangements to ensure they do not encourage excessive risk-taking, and to immediately implement corrective programs if necessary to address deficiencies in arrangements that are inconsistent with safety and soundness.

The Board's proposal is in the form of a Proposed Guidance to better deal with differences among banking organizations and their varied approaches. Formal rules may be viewed as too constraining or too open-ended. The Proposed Guidance will apply to all banking organizations supervised by the Board, which 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 subsidiary in the United States. For such organizations, the Proposed Guidance will apply to incentive compensation arrangements for (i) senior executives and others responsible for oversight of the organization's firmwide activities or material business lines; (ii) individual employees, including non-executives, whose activities may expose the firm to material amounts of risk (such as traders with large positions); and (iii) groups of employees who, in the aggregate, may expose the firm to material amounts of risk, such as loan officers.

The Proposed Guidance is based on three principles. Those principles and their sub-components are the following:

Balanced Risk-Taking Incentives 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. An unbalanced arrangement can be moved toward balance by adding or modifying features that cause the amounts...

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