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FDIC Seeks Comment on Incorporating Employee Compensation Structures into Bank Risk Assessment System

01.29.10

Jacob "Jake" A. Lutz, III

Thomas "Tom" O. Powell

Seth A. Winter

On January 12, 2010, the Federal Deposit Insurance Corporation (FDIC) issued an advance notice of proposed rulemaking (the Proposal) inviting comment on whether the FDIC should charge higher deposit insurance premiums for institutions with compensation plans that encourage excessive risk taking.  At issue are compensation structures that fail to align incentives of individual employees with other stakeholders – namely shareholders and the FDIC.  The Proposal states the FDIC’s position that excessive risk taking by employees remains a contributing factor in financial institution failures and losses to the FDIC insurance fund.

If the FDIC proceeds as outlined in the Proposal, the FDIC would regulate employee compensation by adjusting deposit insurance rates.  As proposed, the FDIC’s regulation would be in addition to the Federal Reserve’s incentive compensation guidelines, which were announced in October 2009.  The Federal Reserve’s guidelines propose that the Federal Reserve regulate incentive compensation and associated risk through the Federal Reserve’s examination process of bank holding companies and Fed member banks.

The Proposal sets forth the FDIC’s intent to identify criteria describing compensation structure and incorporate these criteria into the risk-based assessment structure.  Specifically, the Proposal sets forth three express goals: (1) adjusting the FDIC’s risk-based assessment rates to adequately compensate for risks presented by certain employee compensation programs; (2) using the FDIC’s risk-based assessment rates to provide incentives for insured institutions to adopt employee compensation programs that align employees’ incentives with those of other stakeholders; and (3) promoting the use of compensation programs that reward employee focus on risk management.

The Proposal also highlights certain compensation program elements that may be included in compensation programs that meet the FDIC’s goals, including: (1) employees whose activities present significant risk to the insured institution should be compensated largely in restricted, nondiscounted stock; (2) large stock awards should vest over a multi-year period and be subject to a look-back or claw-back mechanism if risky behavior ultimately leads to losses; and (3) the insured institution’s independent directors should administer the compensation program, with input from independent compensation consultants.

Certain industry groups have expressed concerns that the Proposal could signal the FDIC’s intent to regulate financial institution compensation practices and use FDIC premium payments as its enforcement mechanism.  Other industry professionals worry that the Proposal shows the FDIC approaching a slippery slope toward micromanaging financial institutions through the deposit insurance structure.

The FDIC seeks comment by February 18, 2010 on all aspects of the Proposal, including the FDIC’s stated goals and the features of compensation programs that could meet its goals.  The Proposal, including alternatives for the submission of comments, may be found at http://www.fdic.gov/news/board/2010Jan12ANPR.pdf.

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The foregoing is only a summary of one of the many significant issues affecting financial institutions.  If you have any questions about the foregoing or about other financial institution issues, please direct them to your regular contact at Troutman Sanders LLP or to any of the persons listed in the sidebar to this release.

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