Final Interagency Guidance on Sound Incentive Compensation Policies

An interagency press release on June 21, 2010, announced the final guidance that we have been expecting ever since the Federal Reserve issued preliminary guidance on this topic in October of 2009.  The final guidance is largely unchanged from the Fed’s preliminary guidance, with the exception of a few adjustments/clarifications in response to feedback the Fed received during the open comment period.

Key Facts:

  • Issued on an interagency basis (Federal Reserve, OCC, OTS & FDIC);
  • Effective June 25, 2010 (date published in the Federal Register);
  • Applies to ALL banking organizations supervised by these agencies (no exemption for smaller community banks);
  • Except for the largest banking organizations (LBOs), enforcement of this guidance will be handled through the supervisors’ regular risk-focused examination process;
  • Principles-based, rather than prescriptive/formulaic;
  • Identifies expectations of LBOs that go beyond what will be expected of community banks, and emphasizes that the application of the guidance should be scaled appropriately for the complexity of the organization and the extent to which incentive arrangements are utilized.

Covered Employee Groups:

  • 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 organization to material amounts of risk; and
  • Groups of employees who are subject to the same or similar incentive compensation arrangements and who, in the aggregate, may expose the organization to material amounts of risk, even if no individual employee is likely to expose the organization to material risk.

Three Principles for Safe and Sound Incentive Compensation Arrangements:

  • Balanced Risk-Taking:  Incentive compensation arrangements should balance risk and financial results in a manner that does not encourage employees to expose their organizations to imprudent risks;
  • Compatibility with Effective Controls and Risk-Management:  A banking organization’s risk-management processes and internal controls should reinforce and support the development and maintenance of balanced incentive compensation arrangements;
  • Strong Corporate Governance:  Banking organizations should have strong and effective corporate governance to help ensure sound compensation practices, including active and effective oversight by the board of directors.

Click on the following links to access: