On January 12, 2010, the Board of Directors of the Federal Deposit Insurance Corporation voted to consider taking employee compensation practices into account in setting risk-based insurance premiums for insured depository institutions. The controversial action, taken over the objections of FDIC Board members representing the Office of the Comptroller of the Currency and the Office of Thrift Supervision, presents issues of cost, compliance, and competition for workers and customers for insured depository institutions, their holding companies, and other affiliates. An Advance Notice of Proposed Rulemaking released after the vote seeks public comment on the proposed parameters of the rule. Comments must be filed within 30 days after publication in the Federal Register.
No Specific Standards Set
The FDIC does not propose to impose specific minimum standards on compensation practices or to mandate compensation levels or structures. Instead, it seeks to implement a system of risk-based premiums designed to
- compensate the Deposit Insurance Fund for the risks created by certain compensation practices,
- provide an incentive to insured institutions and their holding companies and affiliates to adopt compensation practices that align employees' interests with those of the insured institution's stakeholders, including the FDIC, and
- promote compensation practices that reward employees for focusing on risk management.
The FDIC appears to contemplate identifying compensation "best practices" that are presumably superior to the minimum standards imposed by an institution's prudential regulator and providing a financial incentive for voluntary adoption.
Proposed Criteria for Risk-based Assessments
The FDIC proposes the following three, non-exclusive criteria for risk-based assessments relating to compensation practices:
- A significant portion of the performance-based compensation paid to employees whose business activities can present significant risk to an insured institution would be paid in the form of non-discounted restricted stock.
- Significant awards of company stock would only vest over a multi-year period and would be subject to a clawback mechanism in cases where risks assumed during the performance measurement period have an adverse effect in subsequent periods.
- The compensation program would be administered by a board committee comprised of independent directors with the advice independent compensation professionals.
Where these factors are present, a lower premium would be assessed and where one or more of these factors is not present, a higher assessment would occur.
The FDIC will also consider a quantitative approach under which a numerical measure of compensation would be compared to a numerical measure of an institution's health, and the result of the comparison would yield a relatively lower or higher assessment. It also seeks input on other, alternate criteria.
Insured Institutions' Costs May be Affected by Affiliates' Practices
The FDIC posits that an insured institution's parent holding company that is not itself accountable to the FDIC may control or substantially influence decisions that affect the institution's risk profile. It further suggests that an individual employed and compensated by both the insured institution and an uninsured affiliate may be encouraged under the affiliate's compensation practices to cause the insured institution to assume excessive risk. As a result, the FDIC is seeking a mechanism to hold insured institutions accountable for the compensation practices of related companies whose practices they do not control. Voluntary non-compliance could be cited by other constituencies in other contexts, subjecting institutions to the possibility of higher costs for such items as examination fees, errors and omissions insurance coverage and increased litigation.
Possible Limits on Application
The FDIC is considering restricting the application of this aspect of risk-based premium assessments to specific classes of institutions perceived to present compensation related risks. For example, the risk-based assessment could be directed only to institutions of a certain size, or to those that engage in certain specified activities such as trading. The FDIC is also considering focusing its risk-based assessments on certain types of compensation arrangements, such as guaranteed bonuses, bonuses that are disproportionate to salary, or bonus payments with no vesting, deferral or clawback feature.
Conclusion
The Advance Notice of Proposed Rulemaking presents many potential concerns for insured institutions and their holding companies and affiliates. As noted by FDIC Board members Dugan and Bowman in their opposition statements, the action tests the breadth of the FDIC's risk-based assessment authority and the intersection of its jurisdiction with those of prudential regulators. Implementation of the proposal will inevitably involve additional costs for affected institutions, whether in the form of increased deposit insurance premiums or costs for adoption of the FDIC's chosen standards. The potential exists for conflict between expected new compensation standards from Congress and prudential regulators, on the one hand, and those required to minimize deposit insurance costs, on the other. Specific challenges may exist for institutions, such as community banks, mutuals, S-corporations and privately held companies, for which the equity and other performance-based compensation features contemplated by the proposal may be infeasible or prohibited by law. And finally, competition with uninsured entities for workers, customers and investor capital may become even more difficult.
Directors Dugan and Bowman have also indicated their concern that the proposal lacks sufficient factual development. To this end, affected institutions may wish to avail themselves of the comment period to help the FDIC understand the proposal's many challenges.
For more information on the subject matter of this alert, please contact W. Edward Bright (212.768.5394 or ebright@sonnenschein.com), Douglas J. McClintock (212.768.6875 or dmcclintock@sonnenschein.com), Robert C. Azarow (212.768.5371 or razarow@sonnenschein.com), Charles D. Bethill (212.768.5393 or cbethill@sonnenschein.com), Matthew Dyckman (202.408.9123 or mdyckman@sonnenschein.com), Gary L. Goldberg (202.408.6396 or ggoldberg@sonnenschein.com), Stephanie G. Nygard (212.768.6915 or snygard@sonnenschein.com), Mark I. Sokolow (212.768.6942 or msokolow@sonnenschein.com) or Michael E. Zolandz (202.408.9204 or mzolandz@sonnenschein.com).
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