[Federal Register Volume 75, Number 122 (Friday, June 25, 2010)]
[Notices]
[Pages 36395-36414]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2010-15435]


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DEPARTMENT OF THE TREASURY

Office of the Comptroller of the Currency

[Docket ID OCC-2010-0013]

FEDERAL RESERVE SYSTEM

[Docket No. OP-1374]

FEDERAL DEPOSIT INSURANCE CORPORATION

DEPARTMENT OF THE TREASURY

Office of Thrift Supervision

[Docket ID OTS-2010-0020]


Guidance on Sound Incentive Compensation Policies

AGENCY: Office of the Comptroller of the Currency, Treasury (OCC); 
Board of Governors of the Federal Reserve System, (Board or Federal 
Reserve);

[[Page 36396]]

Federal Deposit Insurance Corporation (FDIC); Office of Thrift 
Supervision, Treasury (OTS).

ACTION: Final guidance.

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SUMMARY: The OCC, Board, FDIC and OTS (collectively, the Agencies) are 
adopting final guidance designed to help ensure that incentive 
compensation policies at banking organizations do not encourage 
imprudent risk-taking and are consistent with the safety and soundness 
of the organization.

DATES: Effective Date: The guidance is effective on June 25, 2010.

FOR FURTHER INFORMATION CONTACT: 
    OCC: Karen M. Kwilosz, Director, Operational Risk Policy, (202) 
874-9457, or Reggy Robinson, Policy Analyst, Operational Risk Policy, 
(202) 874-4438.
    Board: William F. Treacy, Adviser, (202) 452-3859, Division of 
Banking Supervision and Regulation; Mark S. Carey, Adviser, (202) 452-
2784, Division of International Finance; Kieran J. Fallon, Associate 
General Counsel, (202) 452-5270 or Michael W. Waldron, Counsel, (202) 
452-2798, Legal Division. For users of Telecommunications Device for 
the Deaf (``TDD'') only, contact (202) 263-4869.
    FDIC: Mindy West, Chief, Policy and Program Development, Division 
of Supervision and Consumer Protection, (202) 898-7221, or Robert W. 
Walsh, Review Examiner, Policy and Program Development, Division of 
Supervision and Consumer Protection, (202) 898-6649.
    OTS: Rich Gaffin, Financial Analyst, Risk Modeling and Analysis, 
(202) 906-6181, or Richard Bennett, Senior Compliance Counsel, 
Regulations and Legislation Division, (202) 906-7409; Donna Deale, 
Director, Holding Company and International Policy, (202) 906-7488, 
Grovetta Gardineer, Managing Director, Corporate and International 
Activities, (202) 906-6068; Office of Thrift Supervision, 1700 G 
Street, NW., Washington, DC 20552.

SUPPLEMENTARY INFORMATION: 

I. Background

    Compensation arrangements are critical tools in the successful 
management of financial institutions. These arrangements serve several 
important and worthy objectives, including attracting skilled staff, 
promoting better organization-wide and employee performance, promoting 
employee retention, providing retirement security to employees, and 
allowing an organization's personnel costs to vary along with revenues.
    It is clear, however, that compensation arrangements can provide 
executives and employees with incentives to take imprudent risks that 
are not consistent with the long-term health of the organization. For 
example, offering large payments to managers or employees to produce 
sizable increases in short-term revenue or profit--without regard for 
the potentially substantial short or long-term risks associated with 
that revenue or profit--can encourage managers or employees to take 
risks that are beyond the capability of the financial institution to 
manage and control.
    Flawed incentive compensation practices in the financial industry 
were one of many factors contributing to the financial crisis that 
began in 2007. Banking organizations too often rewarded employees for 
increasing the organization's revenue or short-term profit without 
adequate recognition of the risks the employees' activities posed to 
the organization.
    Having witnessed the damaging consequences that can result from 
misaligned incentives, many financial institutions are now re-examining 
their compensation structures with the goal of better aligning the 
interests of managers and other employees with the long-term health of 
the institution. Aligning the interests of shareholders and employees, 
however, is not always sufficient to protect the safety and soundness 
of a banking organization. Because banking organizations benefit 
directly or indirectly from the protections offered by the Federal 
safety net (including the ability of insured depository institutions to 
raise insured deposits and access the Federal Reserve's discount window 
and payment services), shareholders of a banking organization in some 
cases may be willing to tolerate a degree of risk that is inconsistent 
with the organization's safety and soundness. Thus, a review of 
incentive compensation arrangements and related corporate governance 
practices to ensure that they are effective from the standpoint of 
shareholders is not sufficient to ensure they adequately protect the 
safety and soundness of the organization.

A. Proposed Guidance

    In October 2009, the Federal Reserve issued and requested comment 
on Proposed Guidance on Sound Incentive Compensation Policies 
(``proposed guidance'') to help protect the safety and soundness of 
banking organizations supervised by the Federal Reserve and to promote 
the prompt improvement of incentive compensation practices throughout 
the banking industry.\1\ The proposed guidance was based on three key 
principles. These principles provided that incentive compensation 
arrangements at a banking organization should--
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    \1\ 74 FR 55227 (October 27, 2009).
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     Provide employees incentives that appropriately balance 
risk and reward;
     Be compatible with effective controls and risk-management; 
and
     Be supported by strong corporate governance, including 
active and effective oversight by the organization's board of 
directors.
    Because incentive compensation arrangements for executive and non-
executive employees may pose safety and soundness risks if not properly 
structured, the proposed guidance applied to senior executives as well 
as other employees who, either individually or as part of a group, have 
the ability to expose the relevant banking organization to material 
amounts of risk.
    With respect to the first principle, the proposed guidance, among 
other things, provided that a banking organization should ensure that 
its incentive compensation arrangements do not encourage short-term 
profits at the expense of short- and longer-term risks to the 
organization. Rather, the proposed guidance indicated that banking 
organizations should adjust the incentive compensation provided so that 
employees bear some of the risk associated with their activities. To be 
fully effective, these adjustments should take account of the full 
range of risks that the employees' activities may pose for the 
organization. The proposed guidance highlighted several methods that 
banking organizations could use to adjust incentive compensation awards 
or payments to take account of risk.
    With respect to the second principle, the proposed guidance 
provided that banking organizations should integrate their approaches 
to incentive compensation arrangements with their risk-management and 
internal control frameworks to better monitor and control the risks 
these arrangements may create for the organization. Accordingly, the 
proposed guidance provided that banking organizations should ensure 
that risk-management personnel have an appropriate role in designing 
incentive compensation arrangements and assessing whether the 
arrangements may encourage imprudent risk-taking. In addition, the 
proposed guidance provided that banking organizations should track 
incentive compensation awards and payments, risks taken, and actual 
risk outcomes to

[[Page 36397]]

determine whether incentive compensation payments to employees are 
reduced or adjusted to reflect adverse risk outcomes.
    With respect to the third principle, the proposed guidance provided 
that a banking organization's board of directors should play an 
informed and active role in ensuring that the organization's 
compensation arrangements strike the proper balance between risk and 
profit not only at the initiation of a compensation program, but on an 
ongoing basis. Thus, the proposed guidance provided that boards of 
directors should review and approve key elements of their 
organizations' incentive compensation systems across the organization, 
receive and review periodic evaluations of whether their organizations' 
compensation systems for all major segments of the organization are 
achieving their risk-mitigation objectives, and directly approve the 
incentive compensation arrangements for senior executives.
    The Board's proposed guidance applied to all banking organizations 
supervised by the Federal Reserve. However, the proposed guidance also 
included provisions intended to reflect the diversity among banking 
organizations, both with respect to the scope and complexity of their 
activities, as well as the prevalence and scope of incentive 
compensation arrangements. Thus, for example, the proposed guidance 
provided that the reviews, policies, procedures, and systems 
implemented by a smaller banking organization that uses incentive 
compensation arrangements on a limited basis would be substantially 
less extensive, formalized, and detailed than those at a large, complex 
banking organization (LCBO) \2\ that uses incentive compensation 
arrangements extensively. In addition, because sound incentive 
compensation practices are important to protect the safety and 
soundness of all banking organizations, the Federal Reserve announced 
that it would work with the other Federal banking agencies to promote 
application of the guidance to all banking organizations.
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    \2\ In the proposed guidance (issued by the Federal Reserve), 
the term LCBO was used as this is the term utilized by the Federal 
Reserve in describing such organizations. The final guidance uses 
the term Large Banking Organization (LBO), which encompasses 
terminology utilized by the OCC, FDIC and OTS.
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    The Board invited comment on all aspects of the proposed guidance. 
The Board also specifically requested comments on a number of issues, 
including whether:
     The three core principles are appropriate and sufficient 
to help ensure that incentive compensation arrangements do not threaten 
the safety and soundness of banking organizations;
     There are any material legal, regulatory, or other 
impediments to the prompt implementation of incentive compensation 
arrangements and related processes that would be consistent with those 
principles;
     Formulaic limits on incentive compensation would likely 
promote the safety and soundness of banking organizations, whether 
applied generally or to specific types of employees or banking 
organizations;
     Market forces or practices in the broader financial 
services industry, such as the use of ``golden parachute'' or ``golden 
handshake'' arrangements to retain or attract employees, present 
challenges for banking organizations in developing and maintaining 
balanced incentive compensation arrangements;
     The proposed guidance would impose undue burdens on, or 
have unintended consequences for, banking organizations, particularly 
smaller, less complex organizations, and whether there are ways such 
potential burdens or consequences could be addressed in a manner 
consistent with safety and soundness; and
     There are types of incentive compensation plans, such as 
organization-wide profit sharing plans that provide for distributions 
in a manner that is not materially linked to the performance of 
specific employees or groups of employees, that could and should be 
exempted from, or treated differently under, the guidance because they 
are unlikely to affect the risk-taking incentives of all, or a 
significant number of employees.

B. Supervisory Initiatives

    In connection with the issuance of the proposed guidance, the 
Federal Reserve announced two supervisory initiatives:
     A special horizontal review of incentive compensation 
practices at LCBO's; and
     A review of incentive compensation practices at other 
banking organizations as part of the regular, risk-focused examination 
process for these organizations.
    The horizontal review was designed to assess: The potential for 
these arrangements or practices to encourage imprudent risk-taking; the 
actions an organization has taken or proposes to take to correct 
deficiencies in its incentive compensation practices; and the adequacy 
of the organization's compensation-related risk-management, control, 
and corporate governance processes.

II. Overview of Comments

    The Board received 34 written comments on the proposed guidance, 
which were shared and reviewed by all of the Agencies. Commenters 
included banking organizations, financial services trade associations, 
service providers to financial organizations, representatives of 
institutional shareholders, labor organizations, and individuals. Most 
commenters supported the goal of the proposed guidance--to ensure that 
incentive compensation arrangements do not encourage imprudent or undue 
risk-taking at banking organizations. Commenters also generally 
supported the principles-based approach of the proposed guidance. For 
example, many commenters specifically supported the avoidance of 
formulaic or one-size-fits-all approaches to incentive compensation in 
the proposed guidance. These commenters noted financial organizations 
are very diverse and should be permitted to adopt incentive 
compensation measures that fit their needs, while also being consistent 
with safe and sound operations. Several commenters also asserted that a 
formulaic approach would inevitably lead to exaggerated risk-taking 
incentives in some situations while discouraging employees from taking 
reasonable and appropriate risks in others. One commenter also argued 
that unintended consequences would be more likely to result from a 
``rigid rulemaking'' than from a flexible, principles-based approach.
    Many commenters requested that the Board revise or clarify the 
proposed guidance in one or more respects. For example, several 
commenters asserted that the guidance should impose specific 
restrictions on incentive compensation at banking organizations or 
mandate certain corporate governance or risk-management practices. One 
commenter recommended a requirement that most compensation for senior 
executives be provided in the form of variable, performance-vested 
equity awards that are deferred for at least five years, and that stock 
option compensation be prohibited. Another commenter advocated a ban on 
``golden parachute'' payments and on bonuses based on metrics related 
to one year or less of performance. Other commenters suggested that the 
guidance should require banking organizations to have an independent 
chairman of the board of directors, require annual majority voting for 
all directors, or provide for shareholders to have a vote (so called

[[Page 36398]]

``say-on-pay'' voting provisions) on the incentive compensation 
arrangements for certain employees of banking organizations. Other 
commenters requested that certain types of compensation plans, such as 
organization-wide profit sharing plans or 401(k) plans or plans covered 
by the Employee Retirement Income Security Act (29 U.S.C. 1400 et 
seq.), be exempted from the scope of the guidance because they were 
unlikely to provide employees incentives to expose their banking 
organization to undue risk.
    Several commenters, however, did not support the proposed guidance. 
Some of these commenters felt that the proposed guidance was 
unnecessary and that the principles used in the proposed guidance were 
not needed. These commenters argued that the existing system of 
financial regulation and enforcement is sufficient to address the 
concerns raised in the proposed guidance. Several commenters also 
thought that the proposed guidance was too vague to be helpful, and 
that the ambiguity of the proposed guidance would make compliance more 
difficult, leading to increased costs and regulatory uncertainty. Some 
commenters also argued that the guidance was not warranted because 
there is insufficient evidence that incentive compensation practices 
contributed to safety and soundness or financial stability problems, or 
questioned the authority of the Federal Reserve or the other Federal 
banking agencies to act in this area.
    In addition, a number of commenters expressed concern that the 
proposed guidance would impose undue burden on banking organizations, 
particularly smaller, less complex organizations. These commenters 
believed that incentive compensation practices at smaller banking 
organizations were generally not problematic from a safety and 
soundness perspective.\3\ A number of commenters suggested that all or 
most smaller banking organizations should be exempt from the guidance. 
A number of commenters expressed concerns that the proposed guidance 
would impose unreasonable demands on the boards of directors of banking 
organizations and especially smaller organizations.
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    \3\ On the other hand, one commenter requested that the proposed 
guidance not be enforced differently at larger institutions solely 
because of their size.
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    Several commenters also expressed concern that the proposed 
guidance, if implemented, could impede the ability of banking 
organizations to attract or retain qualified staff and compete with 
other financial services providers. In light of these concerns, some 
commenters suggested that the guidance expressly allow banking 
organizations to enter into such compensation arrangements as they deem 
necessary for recruitment or retention purposes. A number of commenters 
also encouraged the Federal Reserve to work with other domestic and 
foreign supervisors and authorities to promote consistent standards for 
incentive compensation practices at financial institutions and a level 
competitive playing field for financial service providers.
    The comments received on the proposed guidance are further 
discussed below.

III. Final Guidance

    After carefully reviewing the comments on the proposed guidance, 
the Agencies have adopted final guidance that retains the same key 
principles embodied in the proposed guidance, with a number of 
adjustments and clarifications that address matters raised by the 
commenters. These principles are: (1) Incentive compensation 
arrangements at a banking organization should provide employees 
incentives that appropriately balance risk and financial results in a 
manner that does not encourage employees to expose their organizations 
to imprudent risk; (2) these arrangements should be compatible with 
effective controls and risk-management; and (3) these arrangements 
should be supported by strong corporate governance, including active 
and effective oversight by the organization's board of directors. The 
Agencies believe that it is important that incentive compensation 
arrangements at banking organizations do not provide incentives for 
employees to take risks that could jeopardize the safety and soundness 
of the organization. The final guidance seeks to address the safety and 
soundness risks of incentive compensation practices by focusing on the 
basic problem they can pose from a risk-management perspective, that 
is, incentive compensation arrangements--if improperly structured--can 
give employees incentives to take imprudent risks.
    The Agencies believe the principles of the final guidance should 
help protect the safety and soundness of banking organizations and the 
stability of the financial system, and that adoption of the guidance is 
fully consistent with the Agencies' statutory mandate to protect the 
safety and soundness of banking organizations.\4\
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    \4\ See, e.g. 12 U.S.C. 1818(b). The Agencies regularly issue 
supervisory guidance based on the authority in section 8 of the 
Federal Deposit Insurance (FDI) Act. Guidance is used to identify 
practices that the Agencies believe would constitute an unsafe or 
unsound practice and/or identify risk-management systems, controls, 
or other practices that the Agencies believe would assist banking 
organizations in ensuring that they operate in a safe and sound 
manner. Savings associations should also refer to OTS's rule on 
employment contracts 12 CFR 563.39.
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    The final guidance applies to all the banking organizations 
supervised by the Agencies, including national banks, State member 
banks, State nonmember banks, savings associations, U.S. bank holding 
companies, savings and loan holding companies, the U.S. operations of 
foreign banks with a branch, agency or commercial lending company in 
the United States, and Edge and agreement corporations (collectively, 
``banking organizations'').
    A number of changes have been made to the proposed guidance in 
response to comments. For example, the final guidance includes several 
provisions designed to reduce burden on smaller banking organizations 
and other banking organizations that are not significant users of 
incentive compensation. The Agencies also have made a number of changes 
to clarify the scope, intent, and terminology of the final guidance.

A. Scope of Guidance

    Compensation practices were not the sole cause of the financial 
crisis, but they certainly were a contributing cause--a fact recognized 
by 98 percent of the respondents to a survey of banking organizations 
engaged in wholesale banking activities conducted in 2009 by the 
Institute of International Finance and publicly by a number of 
individual financial institutions.\5\ Moreover, the problems caused by 
improper compensation practices were not limited to U.S. financial 
institutions, but were evident at major financial institutions 
worldwide, a fact recognized by international bodies such

[[Page 36399]]

as the Financial Stability Board (FSB) and the Senior Supervisors 
Group.\6\
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    \5\ See, Institute of International Finance, Inc. (2009), 
Compensation in Financial Services: Industry Progress and the Agenda 
for Change (Washington: IIF, March) available at http://www.oliverwyman.com/ow/pdf_files/OW_En_FS_Publ_2009_CompensationInFS.pdf. See also UBS, Shareholder Report on UBS's 
Write-Downs, April 18, 2008, pp. 41-42 (identifies incentive effects 
of UBS compensation practices as contributing factors in losses 
suffered by UBS due to exposure to the subprime mortgage market) 
available at http://www.ubs.com/1/ShowMedia/investors/agm?contentId=140333&name=080418ShareholderReport.pdf.
    \6\ See, Financial Stability Forum (2009), FSF Principles for 
Sound Compensation Practices (87 KB PDF) (Basel, Switzerland: FSF, 
April), available at http://www.financialstabilityboard.org/publications/r_0904b.pdf; and Senior Supervisors Group (2009), 
Risk-management Lessons from the Global Banking Crisis of 2008 
(Basel, Switzerland: SSG, October), available at http://www.newyorkfed.org/newsevents/news/banking/2009/ma091021.html. The 
Financial Stability Forum was renamed the Financial Stability Board 
in April 2009.
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    Because compensation arrangements for executive and non-executive 
employees alike may pose safety and soundness risks if not properly 
structured, these principles and the final guidance apply to senior 
executives as well as other employees who, either individually or as 
part of a group, have the ability to expose the banking organization to 
material amounts of risk.\7\ These employees are referred to as 
``covered employees'' in the final guidance. In response to comments, 
the final guidance clarifies that an employee or group of employees has 
the ability to expose a banking organization to material amounts of 
risk if the employees' activities are material to the organization or 
are material to a business line or operating unit that is itself 
material to the organization.
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    \7\ In response to a number of comments requesting clarification 
regarding the scope of the term ``senior executives'' as used in the 
guidance, the final guidance states that ``senior executive'' 
includes, at a minimum, ``executive officers'' within the meaning of 
the Board's Regulation O (12 CFR 215.2(e)(1)) and, for publicly 
traded companies, ``named officers'' within the meaning of the 
Securities and Exchange Commission's rules on disclosure of 
executive compensation (17 CFR 229.402(a)(3)). Savings associations 
should also refer to OTS's rule on loans by savings associations to 
their executive officers, directors, and principal shareholders. 12 
CFR 563.43.
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    Some commenters suggested that certain categories of employees, 
such as tellers, bookkeepers, administrative assistants, or employees 
who process but do not originate transactions, do not expose banking 
organizations to significant levels of risk and therefore should be 
exempted from coverage under the final guidance. The final guidance, 
like the proposed guidance, indicates that the facts and circumstances 
will determine which jobs or categories of employees have the ability 
to expose the organization to material risks and which jobs or 
categories of employees may be outside the scope of the guidance. The 
final guidance recognizes, for example, that tellers, bookkeepers, 
couriers, and data processing personnel would likely not expose 
organizations to significant risks of the types meant to be addressed 
by the guidance. On the other hand, employees or groups of employees 
who do not originate business or approve transactions could still 
expose a banking organization to material risk in some circumstances. 
Therefore, the Agencies do not believe it would be appropriate to 
provide a blanket exemption from the final guidance for any category of 
covered employees that would apply to all banking organizations.
    After reviewing the comments, the Agencies have retained the 
principles-based framework of the proposed guidance. The Agencies 
believe this approach is the most effective way to address incentive 
compensation practices, given the differences in the size and 
complexity of banking organizations covered by the guidance and the 
complexity, diversity, and range of use of incentive compensation 
arrangements by those organizations. For example, activities and risks 
may vary significantly across banking organizations and across 
employees within a particular banking organization. For this reason, 
the methods used to achieve appropriately risk-sensitive compensation 
arrangements likely will differ across and within organizations, and 
use of a single, formulaic approach likely will provide at least some 
employees with incentives to take imprudent risks.
    The Agencies, however, have not modified the guidance, as some 
commenters requested, to provide that a banking organization may enter 
into incentive compensation arrangements that are inconsistent with the 
principles of safety and soundness whenever the organization believes 
that such action is needed to retain or attract employees. The Agencies 
recognize that while incentive compensation serves a number of 
important goals for banking organizations, including attracting and 
retaining skilled staff, these goals do not override the requirement 
for banking organizations to have incentive compensation systems that 
are consistent with safe and sound operations and that do not encourage 
imprudent risk-taking. The final guidance provides banking 
organizations with considerable flexibility in structuring their 
incentive compensation arrangements in ways that both promote safety 
and soundness and that help achieve the arrangements' other objectives.
    The Agencies are mindful, however, that banking organizations 
operate in both domestic and international competitive environments 
that include financial services providers that are not subject to 
prudential oversight by the Agencies and, thus, not subject to the 
final guidance. The Agencies also recognize that international 
coordination in this area is important both to promote competitive 
balance and to ensure that internationally active banking organizations 
are subject to consistent requirements. For this reason, the Agencies 
will continue to work with their domestic and international 
counterparts to foster sound compensation practices across the 
financial services industry. Importantly, the final guidance is 
consistent with both the Principles for Sound Compensation Practices 
and the related Implementation Standards adopted by the FSB in 2009.\8\ 
A number of commenters expressed concern about the levels of 
compensation paid to some employees of banking organizations. As noted 
above, several commenters requested that the Board eliminate or limit 
certain types of incentive compensation for employees of banking 
organizations. Other commenters advocated that certain forms of 
compensation be required. For example, some commenters urged a ban on 
incentive compensation payments made in stock options, while others 
supported their mandatory use. Comments also were received with regard 
to the use of other types of stock-based compensation, such as 
restricted stock and stock appreciation rights. Consistent with its 
principles-based approach, the final guidance does not mandate or 
prohibit the use of any specific forms of payment for incentive 
compensation or establish mandatory compensation levels or caps. 
Rather, the forms and levels of incentive compensation payments at 
banking organizations are expected to reflect the principles of the 
final guidance in a manner tailored to the business, risk profile, and 
other attributes of the banking organization. Incentive compensation 
structures that offer employees rewards for increasing short-term 
profit or revenue, without taking into account risk, may encourage 
imprudent risk-taking even if they meet formulaic levels or include or 
exclude certain forms of compensation. On the other hand, incentive 
compensation arrangements of various forms and levels may be properly 
structured so as not to encourage imprudent risk-taking.
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    \8\ See, Financial Stability Forum, FSF Principles for Sound 
Compensation Practices, in note 6; and Financial Stability Board 
(2009), FSB Principles for Sound Compensation Practices: 
Implementation Standards (35 KB PDF) (Basel, Switzerland: FSB, 
September), available at http://www.financialstabilityboard.org/publications/r_090925c.pdf.
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    In response to comments, the final guidance clarifies in a number 
of respects the expectation of the Agencies that the impact of the 
final guidance on

[[Page 36400]]

banking organizations will vary depending on the size and complexity of 
the organization and its level of usage of incentive compensation 
arrangements. It is expected that the guidance will generally have less 
impact on smaller banking organizations, which typically are less 
complex and make less use of incentive compensation arrangements than 
larger banking organizations. Because of the size and complexity of 
their operations, large banking organizations (LBOs) \9\ should have 
and adhere to systematic and formalized policies, procedures and 
processes. These are considered important in ensuring that incentive 
compensation arrangements for all covered employees are identified and 
reviewed by appropriate levels of management (including the board of 
directors where appropriate and control units), and that they 
appropriately balance risks and rewards . The final guidance highlights 
the types of policies, procedures, and systems that LBOs should have 
and maintain, but that are not expected of other banking organizations. 
It is expected that, particularly in the case of LBO's, adoption of 
this principles-based approach will require an iterative supervisory 
process to ensure that the embedded flexibility that allows for 
customized arrangements for each banking organization does not 
undermine effective implementation of the guidance.
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    \9\ For purposes of the final guidance, LBOs include, in the 
case of banking organizations supervised by (i) the Federal Reserve, 
large, complex banking organizations as identified by the Federal 
Reserve for supervisory purposes; (ii) the OCC, the largest and most 
complex national banks as defined in the Large Bank Supervision 
booklet of the Comptroller's Handbook; (iii) the FDIC, large complex 
insured depository institutions (IDIs); and (iv) the OTS, the 
largest and most complex savings associations and savings and loan 
holding companies. The term ``smaller banking organizations'' is 
used to refer to banking organizations that are not LBOs under the 
relevant agency's standard.
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    With respect to U.S. operations of foreign banks, incentive 
compensation policies, including management, review, and approval 
requirements for a foreign bank's U.S. operations should be coordinated 
with the foreign banking organization's group-wide policies developed 
in accordance with the rules of the foreign banking organization's home 
country supervisor. These policies and practices should be consistent 
with the foreign bank's overall corporate and management structure and 
its framework for risk-management and internal controls, as well as 
with the final guidance.

B. Balanced Incentive Compensation Arrangements

    The first principle of the final guidance is that incentive 
compensation arrangements should provide employees incentives that 
appropriately balance risks and rewards in a manner that does not 
encourage imprudent risk-taking. The amounts of incentive pay flowing 
to covered employees should take account of and adjust for the risks 
and losses--as well as gains--associated with employees' activities, so 
that employees do not have incentives to take imprudent risk. The 
formulation of this principle is slightly different from that used in 
the proposed guidance, which stated that organizations should provide 
employees incentives that do not encourage imprudent risk-taking beyond 
the organization's ability to effectively identify and manage risk. 
This change was made to clarify that risk-management procedures and 
control functions that ordinarily limit risk-taking do not obviate the 
need to identify covered employees and to develop incentive 
compensation arrangements that properly balance risk-taking incentives. 
To be fully effective, balancing adjustments to incentive compensation 
arrangements should take account of the full range of risks that 
employees' activities may pose for the organization, including credit, 
market, liquidity, operational, legal, compliance, and reputational 
risks.
    A number of commenters expressed the view that increased controls 
could mitigate a lack of balance in incentive compensation 
arrangements. Under this view, unbalanced incentive compensation 
arrangements could be addressed either through the modification of the 
incentive compensation arrangements or through the application of 
additional or more effective risk controls to the business. The final 
guidance recognizes that strong and effective risk-management and 
internal control functions are critical to the safety and soundness of 
banking organizations. However, the Agencies believe that poorly 
designed or managed incentive compensation arrangements can themselves 
be a source of risk to banking organizations and undermine the controls 
in place. Unbalanced incentive compensation arrangements can place 
substantial strain on the risk-management and internal control 
functions of even well-managed organizations. Furthermore, poorly 
balanced incentive compensation arrangements can encourage employees to 
take affirmative actions to weaken the organization's risk-management 
or internal control functions.
    The final guidance, like the proposed guidance, outlines four 
methods that are currently in use to make compensation more sensitive 
to risk. These are risk adjustment of awards; deferral of payment; 
longer performance periods; and reduced sensitivity to short-term 
performance. Each method has advantages and disadvantages. For example, 
incentive compensation arrangements for senior executives at LBOs are 
likely to be better balanced if they involve deferral of a substantial 
portion of the executives' incentive compensation over a multi-year 
period, with payment made in the form of stock or other equity-based 
instruments and with the number of instruments ultimately received 
dependent on the performance of the organization (or, ideally, the 
performance of the executive) during the deferral period. Deferral, 
however, may not be effective in constraining the incentives of 
employees who may have the ability to expose the organization to long-
term risks, as these risks may not be realized during a reasonable 
deferral period. For this reason, the final guidance recognizes that in 
some cases, two or more methods may be needed in combination (e.g., 
risk adjustment of awards and deferral of payment) to achieve an 
incentive compensation arrangement that properly balances risk and 
reward.
    Furthermore, the few methods noted in the final guidance are not 
exclusive, and other effective methods or variations may exist or be 
developed. Methods for achieving balanced compensation arrangements at 
one organization may not be effective at another organization. Each 
organization is responsible for ensuring that its incentive 
compensation arrangements are consistent with the safety and soundness 
of the organization. The guidance clarifies that LBOs should actively 
monitor industry, academic, and regulatory developments in incentive 
compensation practices and theory and be prepared to incorporate into 
their incentive compensation systems new or emerging methods that are 
likely to improve the organization's long-term financial well-being and 
safety and soundness.
    In response to a question asked in the proposed guidance, several 
commenters requested that certain types of compensation plans be 
treated as beyond the scope of the final guidance because commenters 
believed these plans do not threaten the safety and soundness of 
banking organizations. These included organization-wide profit sharing 
plans, 401(k) plans, defined benefit plans, and ERISA plans.

[[Page 36401]]

    The final guidance does not exempt any broad categories of 
compensation plans based on their tax structure, corporate form, or 
status as a retirement or other employee benefit plans, because any 
type of incentive compensation plan may be implemented in a way that 
increases risk inappropriately. In response to these comments, however, 
the final guidance recognizes that the term ``incentive compensation'' 
does not include arrangements that are based solely on the employees' 
level of compensation and that do not vary based on one or more 
performance metrics (e.g., a 401(k) plan under which the organization 
contributes a set percentage of an employee's salary). In addition, the 
final guidance notes that incentive compensation plans that provide for 
awards based solely on overall organization-wide performance are 
unlikely to provide employees, other than senior executives and 
individuals who have the ability to materially affect the 
organization's overall performance, with unbalanced risk-taking 
incentives.
    In many cases, there were comments on both sides of an issue, with 
some wanting less or no guidance and others wanting tough, or very 
specific prohibitions. For example, a number of commenters argued that 
the use of ``golden parachutes'' and similar retention and recruitment 
provisions to retain employees should be prohibited because such 
provisions have been abused in the past.\10\ A larger number of 
commenters, however, argued against a per se ban on such arrangements, 
stating that these provisions were in some cases essential elements of 
effective recruiting and retention packages and are not necessarily a 
threat to safety and soundness. One commenter stated that golden 
parachute payments triggered by changes in control of a banking 
organization are too speculative to encourage imprudent risk-taking by 
employees.
---------------------------------------------------------------------------

    \10\ Arrangements that provide for an employee (typically a 
senior executive), upon departure from an organization or a change 
in control of the organization, to receive large additional payments 
or the accelerated payment of deferred amounts without regard to 
risk or risk outcomes are sometimes called ``golden parachutes.''
---------------------------------------------------------------------------

    The final guidance, like the proposed guidance, provides that 
banking organizations should carefully consider the potential for 
golden parachutes and similar arrangements to affect the risk-taking 
behavior of employees. The final guidance adds language noting that 
arrangements that provide an employee with a guaranteed payout upon 
departure from an organization regardless of performance may neutralize 
the effect of any balancing features included in the arrangement to 
help prevent imprudent risk-taking. Organizations should consider 
including balancing features--such as risk adjustments or deferral 
requirements--in golden parachutes and similar arrangements to mitigate 
the potential for the arrangements to encourage imprudent risk-taking.
    Provisions that require a departing employee to forfeit deferred 
incentive compensation payments may also weaken the effectiveness of a 
deferral arrangement if the departing employee is able to negotiate a 
``golden handshake'' arrangement with the employee's new 
organization.\11\ Golden handshake provisions present special issues 
for banking organizations and supervisors, some of which are discussed 
in the final guidance, because it is the action of the employee's new 
employer--which may not be a regulated institution--that can affect the 
current employer's ability to properly align the employee's interest 
with the organization's long-term health. The final guidance states 
that LBOs should monitor whether golden handshake arrangements are 
materially weakening the organization's efforts to constrain the risk-
taking incentives of employees. The Agencies will continue to work with 
banking organizations and others to develop appropriate methods for 
addressing any effect that such arrangements may have on the safety and 
soundness of banking organizations.
---------------------------------------------------------------------------

    \11\ Golden handshakes are arrangements that compensate an 
employee for some or all of the estimated, non-adjusted value of 
deferred incentive compensation that would have been forfeited upon 
departure from the employee's previous employment.
---------------------------------------------------------------------------

C. Compatibility With Effective Controls and Risk-Management

    The second principle of the final guidance states that a banking 
organization's risk-management processes and internal controls should 
reinforce and support the development and maintenance of balanced 
incentive compensation arrangements. Banking organizations should 
integrate incentive compensation arrangements into their risk-
management and internal control frameworks to ensure that balance is 
achieved. In particular, banking organizations should have appropriate 
controls to ensure that processes for achieving balance are followed. 
Appropriate personnel, including risk-management personnel, should have 
input in the design and assessment of incentive compensation 
arrangements. Compensation for risk-management and control personnel 
should be sufficient to attract and retain appropriately qualified 
personnel and such compensation should not be based substantially on 
the financial performance of the business unit that they review. 
Rather, their performance should be based primarily on the achievement 
of the objectives of their functions (e.g., adherence to internal 
controls).
    Banking organizations should monitor incentive compensation awards, 
risks taken and actual risk outcomes to determine whether incentive 
compensation payments to employees are reduced to reflect adverse risk 
outcomes. Incentive compensation arrangements that are found not to 
appropriately reflect risk should be modified as necessary. 
Organizations should not only provide rewards when performance 
standards are met or exceeded, they should also reduce compensation 
when standards are not met. If senior executives or other employees are 
paid substantially all of their potential incentive compensation when 
risk outcomes are materially worse than expected, employees may be 
encouraged to take large risks in the hope of substantially increasing 
their personal compensation, knowing that their downside risks are 
limited. Simply put, incentive compensation arrangements should not 
create a ``heads I win, tails the firm loses'' expectation.
    A significant number of comments expressed concerns about the scope 
of the applicability of the proposed guidance to smaller banking 
organizations as well as the burden the proposed guidance would impose 
on these organizations. In response to these comments, the final 
guidance has made more explicit the Agencies' view that the monitoring 
methods and processes used by a banking organization should be 
commensurate with the size and complexity of the organization, as well 
as its use of incentive compensation. Thus, for example, a smaller 
organization that uses incentive compensation only to a limited extent 
may find that it can appropriately monitor its arrangements through 
normal management processes. The final guidance also discusses specific 
aspects of policies and procedures related to controls and risk-
management that are applicable to LBOs and are not expected of other 
banking organizations.

D. Strong Corporate Governance

    The third principle of the final guidance is that incentive 
compensation programs at banking organizations should be supported by 
strong corporate governance, including active and effective oversight 
by the organization's

[[Page 36402]]

board of directors.\12\ The board of directors of an organization is 
ultimately responsible for ensuring that the organization's incentive 
compensation arrangements for all covered employees--not solely senior 
executives--are appropriately balanced and do not jeopardize the safety 
and soundness of the organization. Boards of directors should receive 
data and analysis from management or other sources that are sufficient 
to allow the board to assess whether the overall design and performance 
of the organization's incentive compensation arrangements are 
consistent with the organization's safety and soundness. These reviews 
and reports should be appropriately scoped to reflect the size and 
complexity of the banking organization's activities and the prevalence 
and scope of its incentive compensation arrangements. The structure, 
composition, and resources of the board of directors should be 
constructed to permit effective oversight of incentive compensation. 
The board of directors should, for example, have, or have access to, a 
level of expertise and experience in risk-management and compensation 
practices in the financial services sector that is appropriate for the 
nature, scope, and complexity of the organization's activities.\13\
---------------------------------------------------------------------------

    \12\ In the case of foreign banking organizations (FBOs), the 
term ``board of directors'' refers to the relevant oversight body 
for the firm's U.S. operations, consistent with the FBO's overall 
corporate and management structure.
    \13\ Savings associations should also refer to OTS's rule on 
directors, officers, and employees. 12 CFR 563.33.
---------------------------------------------------------------------------

    Given the key role of senior executives in managing the overall 
risk-taking activities of an organization, the board of directors 
should directly approve compensation arrangements involving senior 
executives and closely monitor such payments and their sensitivity to 
risk outcomes. If the compensation arrangements for a senior executive 
include a deferral of payment or ``clawback'' provision, then the 
review should include sufficient information to determine if the 
provision has been triggered and executed as planned. The board also 
should approve and document any material exceptions or adjustments to 
the incentive compensation arrangements established for senior 
executives and should carefully consider and monitor the effects of any 
approved exceptions or adjustments to the arrangements.
    In response to comments expressing concern about the impact of the 
proposed guidance on smaller banking organizations, the final guidance 
identifies specific aspects of the corporate governance provisions of 
the final guidance that are applicable to LBOs or other organizations 
that use incentive compensation to a significant degree, and are not 
expected of other banking organizations. In particular, boards of 
directors of LBOs and other organizations that use incentive 
compensation to a significant degree should actively oversee the 
development and operation of the organization's incentive compensation 
policies, systems and related control processes. If such an 
organization does not already have a compensation committee, reporting 
to the full board, with primary responsibility for incentive 
compensation arrangements, the board should consider establishing one. 
LBOs, in particular, should follow a systematic approach, outlined in 
the final guidance, in developing compensation systems that have 
balanced incentive compensation arrangements.
    Several commenters expressed concern that the proposed guidance 
appeared to create a new substantive qualification for boards of 
directors that requires the boards of all banking organizations to have 
members with expertise in compensation and risk-management issues. A 
group of commenters noted that such a requirement could limit an 
already small pool of people suitable to serve on boards of directors 
of banking organizations and that smaller organizations may not have 
access to, or the resources to compensate, directors meeting these 
additional requirements. Some commenters also stated that terms such as 
``closely monitor'' and ``actively oversee'' could be read to impose a 
higher standard on directors for their oversight of incentive 
compensation issues. On the other hand, one commenter noted that 
current law requires financial expertise on the boards of directors and 
audit committees of public companies and recommended that specialized 
risk-management competencies be required on the boards of all banking 
organizations.
    To address concerns raised by these commenters, the final guidance 
clarifies that risk-management and compensation expertise and 
experience at the board level may be present collectively among the 
members of the board, and may come from formal training or from 
experience in addressing risk-management and compensation issues, 
including as a director, or may be obtained from advice received from 
outside counsel, consultants, or other experts with expertise in 
incentive compensation and risk-management. Furthermore, the final 
guidance recognizes that smaller organizations with less complex and 
extensive incentive compensation arrangements may not find it necessary 
or appropriate to require specially tailored board expertise or to 
retain and use outside experts in this area.
    A banking organization's disclosure practices should support safe 
and sound incentive compensation arrangements. Specifically, a banking 
organization should supply an appropriate amount of information 
concerning its incentive compensation arrangements and related risk-
management, control, and governance processes to shareholders to allow 
them to monitor and, where appropriate, take actions to restrain the 
potential for such arrangements to encourage employees to take 
imprudent risks.
    While some commenters supported increased public disclosure of the 
incentive compensation practices of banking organizations, a greater 
number expressed concerns that any required disclosures of incentive 
compensation information by banking organizations be tailored to 
protect the privacy of employees and take account of the impact of such 
disclosures on the ability of organizations to attract and retain 
talent. Several commenters supported an alignment of required 
disclosures with existing requirements for public companies, arguing 
that additional requirements would add to the regulatory burden on 
banking organizations.
    The proposed guidance did not impose specific disclosure 
requirements on banking organizations. The final guidance makes no 
significant changes from the proposed guidance with regard to 
disclosures, and states that the scope and level of information 
disclosed by a banking organization should be tailored to the nature 
and complexity of the organization and its incentive compensation 
arrangements. The final guidance notes that banking organizations 
should comply with the incentive compensation disclosure requirements 
of the Federal securities law and other laws, as applicable.
    A number of commenters supported additional governance requirements 
for banking organizations, such as ``say on pay'' provisions requiring 
shareholder approval of compensation plans, separation of the board 
chair and chief executive officer positions, majority voting for 
directors, annual elections for all directors, and improvements to the 
audit function. Some of these comments seek changes in Federal laws 
beyond the jurisdiction of the Agencies; others

[[Page 36403]]

address issues--such as ``say on pay'' requirements--that are currently 
under consideration by the Congress. The final guidance does not 
preempt or preclude these proposals, and indicates that the Agencies 
expect organizations to comply with all applicable statutory 
disclosure, voting and other requirements.

E. Continuing Supervisory Initiatives

    The horizontal review of incentive compensation practices at LBOs 
is well underway. While this initiative is being led by the Federal 
Reserve, the other Federal banking agencies are participating in the 
work. Supervisory teams have collected substantial information from 
LBOs concerning existing incentive compensation practices and related 
risk-management and corporate governance processes. In addition, LBOs 
have submitted analyses of shortcomings or ``gaps'' in existing 
practices relative to the principles contained in the proposed 
guidance, as well as plans for addressing identified weaknesses. Some 
organizations already have implemented changes to make their incentive 
compensation arrangements more risk sensitive. Indeed, many 
organizations are recognizing that strong risk-management and control 
systems are not sufficient to protect the organization from undue 
risks, including risks arising from unbalanced incentive compensation 
arrangements. Other organizations have considerably more work to do, 
such as developing processes that can effectively compare incentive 
compensation payments to risks and risk outcomes. The Agencies intend 
to continue to regularly review incentive compensation arrangements and 
related risk-management, control, and corporate governance practices of 
LBOs and to work with these organizations through the supervisory 
process to promptly correct any deficiencies that may be inconsistent 
with safety and soundness.\14\
---------------------------------------------------------------------------

    \14\ For smaller banking organizations, the Federal Reserve is 
gathering consistent information through regularly scheduled 
examinations and the normal supervisory process. The focus of the 
data gathering is to identify the types of incentive plans in place, 
the job types covered and the characteristics, prevalence and level 
of documentation available for those incentive compensation plans. 
After comparing and analyzing the information collected, supervisory 
efforts and expectations will be scaled appropriately to the size 
and complexity of the organization and its incentive compensation 
arrangements. For these smaller banking organizations, the 
expectation is that there will be very limited, if any, targeted 
examination work or supervisory follow-up. To the extent that any of 
these organizations has incentive compensation arrangements, the 
policies and systems necessary to monitor these arrangements are 
expected to be substantially less extensive, formalized and detailed 
than those of larger, more complex organizations.
---------------------------------------------------------------------------

    The Agencies intend to actively monitor the actions being taken by 
banking organizations with respect to incentive compensation 
arrangements and will review and update this guidance as appropriate to 
incorporate best practices that emerge. In addition, in order to 
monitor and encourage improvements, Federal Reserve staff will prepare 
a report, in consultation with the other Federal banking agencies, 
after the conclusion of 2010 on trends and developments in compensation 
practices at banking organizations.

IV. Other Matters

    In accordance with the Paperwork Reduction Act (PRA) of 1995 (44 
U.S.C. 3506; 5 CFR Part 1320 Appendix A.1), the Agencies have 
determined that certain aspects of the final guidance constitute a 
collection of information. The Board made this determination under the 
authority delegated to the Board by the Office of Management and Budget 
(OMB).
    An agency may not conduct or sponsor, and an organization is not 
required to respond to, an information collection unless the 
information collection displays a currently valid OMB control number. 
Any changes to the Agencies' regulatory reporting forms that may be 
made in the future to collect information related to incentive 
compensation arrangements would be addressed in a separate Federal 
Register notice.
    The final guidance includes provisions that state large banking 
organizations (LBOs) should (i) have policies and procedures that 
identify and describe the role(s) of the personnel and units authorized 
to be involved in incentive compensation arrangements, identify the 
source of significant risk-related inputs, establish appropriate 
controls governing these inputs to help ensure their integrity, and 
identify the individual(s) and unit(s) whose approval is necessary for 
the establishment or modification of incentive compensation 
arrangements; (ii) create and maintain sufficient documentation to 
permit an audit of the organization's processes for incentive 
compensation arrangements; (iii) have any material exceptions or 
adjustments to the incentive compensation arrangements established for 
senior executives approved and documented by its board of directors; 
and (iv) have its board of directors receive and review, on an annual 
or more frequent basis, an assessment by management of the 
effectiveness of the design and operation of the organization's 
incentive compensation system in providing risk-taking incentives that 
are consistent with the organization's safety and soundness.
    The OCC, FDIC, and OTS have obtained emergency approval under 5 CFR 
1320.13 for issuance of the guidance and will issue a Federal Register 
notice shortly for 60 days of comment as part of the regular PRA 
clearance process. During the regular PRA clearance process the 
estimated average response time may be re-evaluated.
    The Board has approved the collection of information under its 
delegated authority. As discussed earlier in this notice, on October 
27, 2009, the Board published in the Federal Register a notice 
requesting comment on the proposed Guidance on Sound Incentive 
Compensation Policies (74 FR 55227). The comment period for this notice 
expired November 27, 2009. The Board received three comments that 
specifically addressed paperwork burden. The commenters asserted that 
the hourly estimate of the cost of compliance should be considerably 
higher than the Board projected.
    The final guidance clarifies in a number of respects the 
expectation that the effect of the final guidance on banking 
organizations will vary depending on the size and complexity of the 
organization and its level of use of incentive compensation 
arrangements. For example, the final guidance makes more explicit the 
view that the monitoring methods and processes used by a banking 
organization should be commensurate with the size and complexity of the 
organization, as well as its use of incentive compensation. In 
addition, the final guidance highlights the types of policies, 
procedures, systems, and specific aspects of corporate governance that 
LBOs should have and maintain, but that are not expected of other 
banking organizations.
    In response to comments and taking into account the considerations 
discussed above, the Board is increasing the burden estimate for 
implementing or modifying policies and procedures to monitor incentive 
compensation. For this purpose, consideration of burden is limited to 
items in the final guidance constituting an information collection 
within the meaning of the PRA. The Board estimates that 1,502 large 
respondents would take, on average, 480 hours (two months) to modify 
policies and procedures to monitor incentive compensation. The Board 
estimates that 5,058 small respondents would take, on average, 80 hours 
(two business weeks)

[[Page 36404]]

to establish or modify policies and procedures to monitor incentive 
compensation. The total one-time burden is estimated to be 1,125,600 
hours. In addition, the Board estimates that, on a continuing basis, 
respondents would take, on average, 40 hours (one business week) each 
year to maintain policies and procedures to monitor incentive 
compensation arrangements and estimates the annual on-going burden to 
be 262,400 hours. The total annual PRA burden for this information 
collection is estimated to be 1,388,000 hours.

General Description of Report

    This information collection is authorized pursuant to:
    Board--Sections 11(a), 11(i), 25, and 25A of the Federal Reserve 
Act (12 U.S.C. 248(a), 248(i), 602, and 611,), section 5 of the Bank 
Holding Company Act (12 U.S.C. 1844), and section 7(c) of the 
International Banking Act (12 U.S.C. 3105(c)).
    OCC--12 U.S.C. 161, and Section 39 of the Federal Deposit Insurance 
Act (12 U.S.C. 1831p-1).
    FDIC--Section 39 of the Federal Deposit Insurance Act (12 U.S.C. 
1831p-1).
    OTS--Section 39 of the Federal Deposit Insurance Act (12 U.S.C. 
1831p-1) and Sections 4, 5, and 10 of the Home Owners' Loan Act (12 
U.S.C. 1463, 1464, and 1467a).
    The Agencies expect to review the policies and procedures for 
incentive compensation arrangements as part of their supervisory 
processes. To the extent the Agencies collect information during an 
examination of a banking organization, confidential treatment may be 
afforded to the records under exemption 8 of the Freedom of Information 
Act (FOIA), 5 U.S.C. 552(b)(8).

Board

    Title of Information Collection: Recordkeeping Provisions 
Associated with the Guidance on Sound Incentive Compensation Policies.
    Agency form number: FR 4027.
    OMB control number: 7100--to be assigned.
    Frequency: Annually.
    Affected Public: Businesses or other for-profit.
    Respondents: 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.
    Estimated average hours per response: Implementing or modifying 
policies and procedures: large respondents 480 hours; small respondents 
80 hours. Maintenance of policies and procedures: 40 hours.
    Estimated number of respondents: Large respondents, 1,502; Small 
respondents, 5,058.
    Estimated total annual burden: 1,388,000 hours.
    As mentioned above, the OCC, FDIC, and OTS have obtained emergency 
approval under 5 CFR 1320.13. The OCC and OTS approvals were obtained 
prior to the Board revising its burden estimates based on the comments 
received. For this reason, the OCC and OTS are publishing in this 
notice the original burden estimates. They will issue a Federal 
Register notice shortly for 60 days of comment as part of the regular 
PRA clearance process. During the regular PRA clearance process the 
estimated average response time may be re-evaluated based on comments 
received. The FDIC is publishing in this notice the revised burden 
estimates developed by the Board based on the comments received. The 
FDIC will issue a Federal Register notice shortly for 60 days of 
comment as part of the regular PRA clearance process and, during the 
regular PRA clearance process, the estimated average response time may 
be re-evaluated based on comments received.

OCC

    Title of Information Collection: Guidance on Sound Incentive 
Compensation Policies.
    Agency form number: N/A.
    OMB control number: 1557-0245.
    Frequency: Annually.
    Affected Public: Businesses or other for-profit.
    Respondents: National banks.
    Estimated average hours per response: 40 hours.
    Estimated number of respondents: 1,650.
    Estimated total annual burden: 66,000 hours.

FDIC

    Title of Information Collection: Guidance on Sound Incentive 
Compensation Policies.
    Agency form number: N/A.
    OMB control number: 3064-0175.
    Frequency: Annually.
    Affected Public: Businesses or other for-profit.
    Respondents: Insured State nonmember banks.
    Estimated average hours per response: Implementing or modifying 
policies and procedures: large respondents 480 hours; small respondents 
80 hours. Maintenance of policies and procedures: 40 hours.
    Estimated number of respondents: Implementing or modifying policies 
and procedures: large respondents--20; small respondents--4,870; 
Maintenance of policies and procedures: 4,890.
    Estimated total annual burden: 594,800 hours.

OTS

    Title of Information Collection: Sound Incentive Compensation 
Guidance.
    Agency form number: N/A.
    OMB control number: 1550-0129.
    Frequency: Annually.
    Affected Public: Businesses or other for-profit.
    Respondents: Savings associations.
    Estimated average hours per response: 40 hours.
    Estimated number of respondents: 765.
    Estimated total annual burden: 30,600 hours.
    The Agencies have a continuing interest in the public's opinions of 
our collections of information. At any time, comments regarding the 
burden estimate or any other aspect of this collection of information, 
including suggestions for reducing the burden, may be sent to:

Board

    Secretary, Board of Governors of the Federal Reserve System, 20th 
and C Streets, NW., Washington, DC 20551.

OCC

    Communications Division, Office of the Comptroller of the Currency, 
Mailstop 2-3, Attention: 1557-0245, 250 E Street, SW., Washington, DC 
20219. In addition, comments may be sent by fax to (202) 874-5274 or by 
electronic mail to [email protected]. You may personally 
inspect and photocopy comments at the OCC, 250 E Street, SW., 
Washington, DC 20219. For security reasons, the OCC requires that 
visitors make an appointment to inspect comments. You may do so by 
calling (202) 874-4700. Upon arrival, visitors will be required to 
present valid government-issued photo identification and to submit to 
security screening in order to inspect and photocopy comments.

FDIC

    All comments should refer to the name of the collection, ``Guidance 
on Sound Incentive Compensation Policies.'' Comments may be submitted 
by any of the following methods:
     http:[sol][sol]www.FDIC.gov/regulations/laws/federal/
propose.html.
     E-mail: [email protected].
     Mail: Gary Kuiper (202.898.3877), Counsel, Federal Deposit 
Insurance

[[Page 36405]]

Corporation, F-1072, 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.

OTS

    Information Collection Comments, Chief Counsel's Office, Office of 
Thrift Supervision, 1700 G Street, NW., Washington, DC 20552; send a 
facsimile transmission to (202) 906-6518; or send an e-mail to 
[email protected]. OTS will post comments and the 
related index on the OTS Internet Site at 
http:[sol][sol]www.ots.treas.gov. In addition, interested persons may 
inspect comments at the Public Reading Room, 1700 G Street, NW., 
Washington DC 20552 by appointment. To make an appointment, call (202) 
906-5922, send an e-mail to public.info@ots.treas.gov">public.info@ots.treas.gov, or send a 
facsimile transmission to (202) 906-7755.

OMB

    Additionally, please send a copy of your comments by mail to: 
Office of Management and Budget, 725 17th Street, NW., 10235, 
Paperwork Reduction Project (insert Agency OMB control number), 
Washington, DC 20503. Comments can also be sent by fax to (202) 395-
6974.
    While the Regulatory Flexibility Act (5 U.S.C. 603(b)) does not 
apply to this guidance, because it is not being adopted as a rule, the 
Agencies have considered the potential impact of the proposed guidance 
on small banking organizations. For the reasons discussed in the 
SUPPLEMENTARY INFORMATION above, the Agencies believe that issuance of 
the proposed guidance is needed to help ensure that incentive 
compensation arrangements do not pose a threat to the safety and 
soundness of banking organizations, including small banking 
organizations. The Board in the proposed guidance sought comment on 
whether the guidance would impose undue burdens on, or have unintended 
consequences for, small organizations and whether there were ways such 
potential burdens or consequences could be addressed in a manner 
consistent with safety and soundness.
    It is estimated that the guidance will apply to 8,763 small banking 
organizations. See 13 CFR 121.201. As noted in the ``Supplementary 
Information'' above, a number of commenters expressed concern that the 
proposed guidance would impose undue burden on smaller organizations. 
The Agencies have carefully considered the comments received on this 
issue. In response to these comments, the final guidance includes 
several provisions designed to reduce burden on smaller banking 
organizations. For example, the final guidance has made more explicit 
the Agencies' view that the monitoring methods and processes used by a 
banking organization should be commensurate with the size and 
complexity of the organization, as well as its use of incentive 
compensation. The final guidance also highlights the types of policies, 
procedures, and systems that LBOs should have and maintain, but that 
are not expected of other banking organizations. Like the proposed 
guidance, the final guidance focuses on those employees who have the 
ability, either individually or as part of a group, to expose a banking 
organization to material amounts of risk and is tailored to account for 
the differences between large and small banking organizations.

V. Final Guidance

    The text of the final guidance is as follows:

Guidance on Sound Incentive Compensation Policies

I. Introduction
    Incentive compensation practices in the financial industry were one 
of many factors contributing to the financial crisis that began in mid-
2007. Banking organizations too often rewarded employees for increasing 
the organization's revenue or short-term profit without adequate 
recognition of the risks the employees' activities posed to the 
organization.\1\ These practices exacerbated the risks and losses at a 
number of banking organizations and resulted in the misalignment of the 
interests of employees with the long-term well-being and safety and 
soundness of their organizations. This document provides guidance on 
sound incentive compensation practices to banking organizations 
supervised by the Federal Reserve, the Office of the Comptroller of the 
Currency, the Federal Deposit Insurance Corporation, and the Office of 
Thrift Supervision (collectively, the ``Agencies'').\2\ This guidance 
is intended to assist banking organizations in designing and 
implementing incentive compensation arrangements and related policies 
and procedures that effectively consider potential risks and risk 
outcomes.\3\
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    \1\ Examples of risks that may present a threat to the 
organization's safety and soundness include credit, market, 
liquidity, operational, legal, compliance, and reputational risks.
    \2\ As used in this guidance, the term ``banking organization'' 
includes national banks, State member banks, State nonmember banks, 
savings associations, U.S. bank holding companies, savings and loan 
holding companies, Edge and agreement corporations, and the U.S. 
operations of foreign banking organizations (FBOs) with a branch, 
agency, or commercial lending company in the United States.
    \3\ This guidance and the principles reflected herein are 
consistent with the Principles for Sound Compensation Practices 
issued by the Financial Stability Board (FSB) in April 2009, and 
with the FSB's Implementation Standards for those principles, issued 
in September 2009.
---------------------------------------------------------------------------

    Alignment of incentives provided to employees with the interests of 
shareholders of the organization often also benefits safety and 
soundness. However, aligning employee incentives with the interests of 
shareholders is not always sufficient to address safety-and-soundness 
concerns. Because of the presence of the Federal safety net, (including 
the ability of insured depository institutions to raise insured 
deposits and access the Federal Reserve's discount window and payment 
services), shareholders of a banking organization in some cases may be 
willing to tolerate a degree of risk that is inconsistent with the 
organization's safety and soundness. Accordingly, the Agencies expect 
banking organizations to maintain incentive compensation practices that 
are consistent with safety and soundness, even when these practices go 
beyond those needed to align shareholder and employee interests.
    To be consistent with safety and soundness, incentive compensation 
arrangements \4\ at a banking organization should:
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    \4\ In this guidance, the term ``incentive compensation'' refers 
to that portion of an employee's current or potential compensation 
that is tied to achievement of one or more specific metrics (e.g., a 
level of sales, revenue, or income). Incentive compensation does not 
include compensation that is awarded solely for, and the payment of 
which is solely tied to, continued employment (e.g., salary). In 
addition, the term does not include compensation arrangements that 
are determined based solely on the employee's level of compensation 
and does not vary based on one or more performance metrics (e.g., a 
401(k) plan under which the organization contributes a set 
percentage of an employee's salary).
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     Provide employees incentives that appropriately balance 
risk and reward;
     Be compatible with effective controls and risk-management; 
and
     Be supported by strong corporate governance, including 
active and effective oversight by the organization's board of 
directors.
    These principles, and the types of policies, procedures, and 
systems that banking organizations should have to help ensure 
compliance with them, are discussed later in this guidance.
    The Agencies expect banking organizations to regularly review their 
incentive compensation arrangements

[[Page 36406]]

for all executive and non-executive employees who, either individually 
or as part of a group, have the ability to expose the organization to 
material amounts of risk, as well as to regularly review the risk-
management, control, and corporate governance processes related to 
these arrangements. Banking organizations should immediately address 
any identified deficiencies in these arrangements or processes that are 
inconsistent with safety and soundness. Banking organizations are 
responsible for ensuring that their incentive compensation arrangements 
are consistent with the principles described in this guidance and that 
they do not encourage employees to expose the organization to imprudent 
risks that may pose a threat to the safety and soundness of the 
organization.
    The Agencies recognize that incentive compensation arrangements 
often seek to serve several important and worthy objectives. For 
example, incentive compensation arrangements may be used to help 
attract skilled staff, induce better organization-wide and employee 
performance, promote employee retention, provide retirement security to 
employees, or allow compensation expenses to vary with revenue on an 
organization-wide basis. Moreover, the analysis and methods for 
ensuring that incentive compensation arrangements take appropriate 
account of risk should be tailored to the size, complexity, business 
strategy, and risk tolerance of each organization. The resources 
required will depend upon the complexity of the firm and its use of 
incentive compensation arrangements. For some, the task of designing 
and implementing compensation arrangements that properly offer 
incentives for executive and non-executive employees to pursue the 
organization's long-term well-being and that do not encourage imprudent 
risk-taking is a complex task that will require the commitment of 
adequate resources.
    While issues related to designing and implementing incentive 
compensation arrangements are complex, the Agencies are committed to 
ensuring that banking organizations move forward in incorporating the 
principles described in this guidance into their incentive compensation 
practices.\5\
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    \5\ In December 2009 the Federal Reserve, working with the other 
Agencies, initiated a special horizontal review of incentive 
compensation arrangements and related risk-management, control, and 
corporate governance practices of large banking organizations 
(LBOs). This initiative was designed to spur and monitor the 
industry's progress towards the implementation of safe and sound 
incentive compensation arrangements, identify emerging best 
practices, and advance the state of practice more generally in the 
industry.
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    As discussed further below, because of the size and complexity of 
their operations, LBOs \6\ should have and adhere to systematic and 
formalized policies, procedures, and processes. These are considered 
important in ensuring that incentive compensation arrangements for all 
covered employees are identified and reviewed by appropriate levels of 
management (including the board of directors where appropriate and 
control units), and that they appropriately balance risks and rewards. 
In several places, this guidance specifically highlights the types of 
policies, procedures, and systems that LBOs should have and maintain, 
but that generally are not expected of smaller, less complex 
organizations. LBOs warrant the most intensive supervisory attention 
because they are significant users of incentive compensation 
arrangements and because flawed approaches at these organizations are 
more likely to have adverse effects on the broader financial system. 
The Agencies will work with LBOs as necessary through the supervisory 
process to ensure that they promptly correct any deficiencies that may 
be inconsistent with the safety and soundness of the organization.
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    \6\ For supervisory purposes, the Agencies segment organizations 
they supervise into different supervisory portfolios based on, among 
other things, size, complexity, and risk profile. For purposes of 
the final guidance, LBOs include, in the case of banking 
organizations supervised by (i) the Federal Reserve, large, complex 
banking organizations as identified by the Federal Reserve for 
supervisory purposes; (ii) the OCC, the largest and most complex 
national banks as defined in the Large Bank Supervision booklet of 
the Comptroller's Handbook; (iii) the FDIC, large, complex insured 
depository institutions (IDIs); and (iv) the OTS, the largest and 
most complex savings associations and savings and loan holding 
companies.
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    The policies, procedures, and systems of smaller banking 
organizations that use incentive compensation arrangements \7\ are 
expected to be less extensive, formalized, and detailed than those of 
LBOs. Supervisory reviews of incentive compensation arrangements at 
smaller, less-complex banking organizations will be conducted by the 
Agencies as part of the evaluation of those organizations' risk-
management, internal controls, and corporate governance during the 
regular, risk-focused examination process. These reviews will be 
tailored to reflect the scope and complexity of an organization's 
activities, as well as the prevalence and scope of its incentive 
compensation arrangements. Little, if any, additional examination work 
is expected for smaller banking organizations that do not use, to a 
significant extent, incentive compensation arrangements.\8\
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    \7\ This guidance does not apply to banking organizations that 
do not use incentive compensation.
    \8\ To facilitate these reviews, where appropriate, a smaller 
banking organization should review its compensation arrangements to 
determine whether it uses incentive compensation arrangements to a 
significant extent in its business operations. A smaller banking 
organization will not be considered a significant user of incentive 
compensation arrangements simply because the organization has a 
firm-wide profit-sharing or bonus plan that is based on the bank's 
profitability, even if the plan covers all or most of the 
organization's employees.
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    For all banking organizations, supervisory findings related to 
incentive compensation will be communicated to the organization and 
included in the relevant report of examination or inspection. In 
addition, these findings will be incorporated, as appropriate, into the 
organization's rating component(s) and subcomponent(s) relating to 
risk-management, internal controls, and corporate governance under the 
relevant supervisory rating system, as well as the organization's 
overall supervisory rating.
    An organization's appropriate Federal supervisor may take 
enforcement action against a banking organization if its incentive 
compensation arrangements or related risk-management, control, or 
governance processes pose a risk to the safety and soundness of the 
organization, particularly when the organization is not taking prompt 
and effective measures to correct the deficiencies. For example, the 
appropriate Federal supervisor may take an enforcement action if 
material deficiencies are found to exist in the organization's 
incentive compensation arrangements or related risk-management, 
control, or governance processes, or the organization fails to promptly 
develop, submit, or adhere to an effective plan designed to ensure that 
its incentive compensation arrangements do not encourage imprudent 
risk-taking and are consistent with principles of safety and soundness. 
As provided under section 8 of the Federal Deposit Insurance Act (12 
U.S.C. 1818), an enforcement action may, among other things, require an 
organization to take affirmative action, such as developing a 
corrective action plan that is acceptable to the appropriate Federal 
supervisor to rectify safety-and-soundness deficiencies in its 
incentive compensation arrangements or related processes. Where 
warranted, the appropriate Federal supervisor may require the 
organization to take additional affirmative action to correct or remedy 
deficiencies related to the

[[Page 36407]]

organization's incentive compensation practices.
    Effective and balanced incentive compensation practices are likely 
to evolve significantly in the coming years, spurred by the efforts of 
banking organizations, supervisors, and other stakeholders. The 
Agencies will review and update this guidance as appropriate to 
incorporate best practices that emerge from these efforts.
II. Scope of Application
    The incentive compensation arrangements and related policies and 
procedures of banking organizations should be consistent with 
principles of safety and soundness.\9\ Incentive compensation 
arrangements for executive officers as well as for non-executive 
personnel who have the ability to expose a banking organization to 
material amounts of risk may, if not properly structured, pose a threat 
to the organization's safety and soundness. Accordingly, this guidance 
applies to incentive compensation arrangements for:
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    \9\ In the case of the U.S. operations of FBOs, the 
organization's policies, including management, review, and approval 
requirements for its U.S. operations, should be coordinated with the 
FBO's group-wide policies developed in accordance with the rules of 
the FBO's home country supervisor. The policies of the FBO's U.S. 
operations should also be consistent with the FBO's overall 
corporate and management structure, as well as its framework for 
risk-management and internal controls. In addition, the policies for 
the U.S. operations of FBOs should be consistent with this guidance.
---------------------------------------------------------------------------

     Senior executives and others who are responsible for 
oversight of the organization's firm-wide activities or material 
business lines; \10\
---------------------------------------------------------------------------

    \10\ Senior executives include, at a minimum, ``executive 
officers'' within the meaning of the Federal Reserve's Regulation O 
(see 12 CFR 215.2(e)(1)) and, for publicly traded companies, ``named 
officers'' within the meaning of the Securities and Exchange 
Commission's rules on disclosure of executive compensation (see 17 
CFR 229.402(a)(3)). Savings associations should also refer to OTS's 
rule on loans by saving associations to their executive officers, 
directors, and principal shareholders. (12 CFR 563.43).
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     Individual employees, including non-executive employees, 
whose activities may expose the organization to material amounts of 
risk (e.g., traders with large position limits relative to the 
organization's overall risk tolerance); 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 (e.g., loan officers who, as a group, originate loans that account 
for a material amount of the organization's credit risk).
    For ease of reference, these executive and non-executive employees 
are collectively referred to hereafter as ``covered employees'' or 
``employees.'' Depending on the facts and circumstances of the 
individual organization, the types of employees or categories of 
employees that are outside the scope of this guidance because they do 
not have the ability to expose the organization to material risks would 
likely include, for example, tellers, bookkeepers, couriers, or data 
processing personnel.
    In determining whether an employee, or group of employees, may 
expose a banking organization to material risk, the organization should 
consider the full range of inherent risks arising from, or generated 
by, the employee's activities, even if the organization uses risk-
management processes or controls to limit the risks such activities 
ultimately may pose to the organization. Moreover, risks should be 
considered to be material for purposes of this guidance if they are 
material to the organization, or are material to a business line or 
operating unit that is itself material to the organization.\11\ For 
purposes of illustration, assume that a banking organization has a 
structured-finance unit that is material to the organization. A group 
of employees within that unit who originate structured-finance 
transactions that may expose the unit to material risks should be 
considered ``covered employees'' for purposes of this guidance even if 
those transactions must be approved by an independent risk function 
prior to consummation, or the organization uses other processes or 
methods to limit the risk that such transactions may present to the 
organization.
---------------------------------------------------------------------------

    \11\ Thus, risks may be material to an organization even if they 
are not large enough to themselves threaten the solvency of the 
organization.
---------------------------------------------------------------------------

    Strong and effective risk-management and internal control functions 
are critical to the safety and soundness of banking organizations. 
However, irrespective of the quality of these functions, poorly 
designed or managed incentive compensation arrangements can themselves 
be a source of risk to a banking organization. For example, incentive 
compensation arrangements that provide employees strong incentives to 
increase the organization's short-term revenues or profits, without 
regard to the short- or long-term risk associated with such business, 
can place substantial strain on the risk-management and internal 
control functions of even well-managed organizations.
    Moreover, poorly balanced incentive compensation arrangements can 
encourage employees to take affirmative actions to weaken or circumvent 
the organization's risk-management or internal control functions, such 
as by providing inaccurate or incomplete information to these 
functions, to boost the employee's personal compensation. Accordingly, 
sound compensation practices are an integral part of strong risk-
management and internal control functions. A key goal of this guidance 
is to encourage banking organizations to incorporate the risks related 
to incentive compensation into their broader risk-management framework. 
Risk-management procedures and risk controls that ordinarily limit 
risk-taking do not obviate the need for incentive compensation 
arrangements to properly balance risk-taking incentives.
III. Principles of a Sound Incentive Compensation System
Principle 1: Balanced Risk-Taking Incentives
    Incentive compensation arrangements should balance risk and 
financial results in a manner that does not encourage employees to 
expose their organizations to imprudent risks.
    Incentive compensation arrangements typically attempt to encourage 
actions that result in greater revenue or profit for the organization. 
However, short-run revenue or profit can often diverge sharply from 
actual long-run profit because risk outcomes may become clear only over 
time. Activities that carry higher risk typically yield higher short-
term revenue, and an employee who is given incentives to increase 
short-term revenue or profit, without regard to risk, will naturally be 
attracted to opportunities to expose the organization to more risk.
    An incentive compensation arrangement is balanced when the amounts 
paid to an employee appropriately take into account the risks 
(including compliance risks), as well as the financial benefits, from 
the employee's activities and the impact of those activities on the 
organization's safety and soundness. As an example, under a balanced 
incentive compensation arrangement, two employees who generate the same 
amount of short-term revenue or profit for an organization should not 
receive the same amount of incentive compensation if the risks taken by 
the employees in generating that revenue or profit differ materially. 
The employee whose activities create materially larger risks for the 
organization should receive

[[Page 36408]]

less than the other employee, all else being equal.
    The performance measures used in an incentive compensation 
arrangement have an important effect on the incentives provided 
employees and, thus, the potential for the arrangement to encourage 
imprudent risk-taking. For example, if an employee's incentive 
compensation payments are closely tied to short-term revenue or profit 
of business generated by the employee, without any adjustments for the 
risks associated with the business generated, the potential for the 
arrangement to encourage imprudent risk-taking may be quite strong. 
Similarly, traders who work with positions that close at year-end could 
have an incentive to take large risks toward the end of a year if there 
is no mechanism for factoring how such positions perform over a longer 
period of time. The same result could ensue if the performance measures 
themselves lack integrity or can be manipulated inappropriately by the 
employees receiving incentive compensation.
    On the other hand, if an employee's incentive compensation payments 
are determined based on performance measures that are only distantly 
linked to the employee's activities (e.g., for most employees, 
organization-wide profit), the potential for the arrangement to 
encourage the employee to take imprudent risks on behalf of the 
organization may be weak. For this reason, plans that provide for 
awards based solely on overall organization-wide performance are 
unlikely to provide employees, other than senior executives and 
individuals who have the ability to materially affect the 
organization's overall risk profile, with unbalanced risk-taking 
incentives.
    Incentive compensation arrangements should not only be balanced in 
design, they also should be implemented so that actual payments vary 
based on risks or risk outcomes. If, for example, employees are paid 
substantially all of their potential incentive compensation even when 
risk or risk outcomes are materially worse than expected, employees 
have less incentive to avoid activities with substantial risk.
     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.
    The activities of employees may create a wide range of risks for a 
banking organization, such as credit, market, liquidity, operational, 
legal, compliance, and reputational risks, as well as other risks to 
the viability or operation of the organization. Some of these risks may 
be realized in the short term, while others may become apparent only 
over the long term. For example, future revenues that are booked as 
current income may not materialize, and short-term profit-and-loss 
measures may not appropriately reflect differences in the risks 
associated with the revenue derived from different activities (e.g., 
the higher credit or compliance risk associated with subprime loans 
versus prime loans).\12\ In addition, some risks (or combinations of 
risky strategies and positions) may have a low probability of being 
realized, but would have highly adverse effects on the organization if 
they were to be realized (``bad tail risks''). While shareholders may 
have less incentive to guard against bad tail risks because of the 
infrequency of their realization and the existence of the Federal 
safety net, these risks warrant special attention for safety-and-
soundness reasons given the threat they pose to the organization's 
solvency and the Federal safety net.
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    \12\ Importantly, the time horizon over which a risk outcome may 
be realized is not necessarily the same as the stated maturity of an 
exposure. For example, the ongoing reinvestment of funds by a cash 
management unit in commercial paper with a one-day maturity not only 
exposes the organization to one-day credit risk, but also exposes 
the organization to liquidity risk that may be realized only 
infrequently.
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    Banking organizations should consider the full range of current and 
potential risks associated with the activities of covered employees, 
including the cost and amount of capital and liquidity needed to 
support those risks, in developing balanced incentive compensation 
arrangements. Reliable quantitative measures of risk and risk outcomes 
(``quantitative measures''), where available, may be particularly 
useful in developing balanced compensation arrangements and in 
assessing the extent to which arrangements are properly balanced. 
However, reliable quantitative measures may not be available for all 
types of risk or for all activities, and their utility for use in 
compensation arrangements varies across business lines and employees. 
The absence of reliable quantitative measures for certain types of 
risks or outcomes does not mean that banking organizations should 
ignore such risks or outcomes for purposes of assessing whether an 
incentive compensation arrangement achieves balance. For example, while 
reliable quantitative measures may not exist for many bad-tail risks, 
it is important that such risks be considered given their potential 
effect on safety and soundness. As in other risk-management areas, 
banking organizations should rely on informed judgments, supported by 
available data, to estimate risks and risk outcomes in the absence of 
reliable quantitative risk measures.
    Large banking organizations. In designing and modifying incentive 
compensation arrangements, LBOs should assess in advance of 
implementation whether such arrangements are likely to provide balanced 
risk-taking incentives. Simulation analysis of incentive compensation 
arrangements is one way of doing so. Such analysis uses forward-looking 
projections of incentive compensation awards and payments based on a 
range of performance levels, risk outcomes, and levels of risks taken. 
This type of analysis, or other analysis that results in assessments of 
likely effectiveness, can help an LBO assess whether incentive 
compensation awards and payments to an employee are likely to be 
reduced appropriately as the risks to the organization from the 
employee's activities increase.
     An unbalanced arrangement can be moved toward balance by 
adding or modifying features that cause the amounts ultimately received 
by employees to appropriately reflect risk and risk outcomes.
    If an incentive compensation arrangement may encourage employees to 
expose their banking organization to imprudent risks, the organization 
should modify the arrangement as needed to ensure that it is consistent 
with safety and soundness. Four methods are often used to make 
compensation more sensitive to risk. These methods are:
    [cir] Risk Adjustment of Awards: The amount of an incentive 
compensation award for an employee is adjusted based on measures that 
take into account the risk the employee's activities may pose to the 
organization. Such measures may be quantitative, or the size of a risk 
adjustment may be set judgmentally, subject to appropriate oversight.
    [cir] Deferral of Payment: The actual payout of an award to an 
employee is delayed significantly beyond the end of the performance 
period, and the amounts paid are adjusted for actual losses or other 
aspects of performance that are realized or become better known only 
during the deferral period.\13\ Deferred payouts may be

[[Page 36409]]

altered according to risk outcomes either formulaically or 
judgmentally, subject to appropriate oversight. To be most effective, 
the deferral period should be sufficiently long to allow for the 
realization of a substantial portion of the risks from employee 
activities, and the measures of loss should be clearly explained to 
employees and closely tied to their activities during the relevant 
performance period.
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    \13\ The deferral-of-payment method is sometimes referred to in 
the industry as a ``clawback.'' The term ``clawback'' also may refer 
specifically to an arrangement under which an employee must return 
incentive compensation payments previously received by the employee 
(and not just deferred) if certain risk outcomes occur. Section 304 
of the Sarbanes-Oxley Act of 2002 (15 U.S.C. 7243), which applies to 
chief executive officers and chief financial officers of public 
banking organizations, is an example of this more specific type of 
``clawback'' requirement.
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    [cir] Longer Performance Periods: The time period covered by the 
performance measures used in determining an employee's award is 
extended (for example, from one year to two or more years). Longer 
performance periods and deferral of payment are related in that both 
methods allow awards or payments to be made after some or all risk 
outcomes are realized or better known.
    [cir] Reduced Sensitivity to Short-Term Performance: The banking 
organization reduces the rate at which awards increase as an employee 
achieves higher levels of the relevant performance measure(s). Rather 
than offsetting risk-taking incentives associated with the use of 
short-term performance measures, this method reduces the magnitude of 
such incentives. This method also can include improving the quality and 
reliability of performance measures in taking into account both short-
term and long-term risks, for example improving the reliability and 
accuracy of estimates of revenues and long-term profits upon which 
performance measures depend.\14\
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    \14\ Performance targets may have a material effect on risk-
taking incentives. Such targets may offer employees greater rewards 
for increments of performance that are above the target or may 
provide that awards will be granted only if a target is met or 
exceeded. Employees may be particularly motivated to take imprudent 
risk in order to reach performance targets that are aggressive, but 
potentially achievable.
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    These methods for achieving balance are not exclusive, and 
additional methods or variations may exist or be developed. Moreover, 
each method has its own advantages and disadvantages. For example, 
where reliable risk measures exist, risk adjustment of awards may be 
more effective than deferral of payment in reducing incentives for 
imprudent risk-taking. This is because risk adjustment potentially can 
take account of the full range and time horizon of risks, rather than 
just those risk outcomes that occur or become more evident during the 
deferral period. On the other hand, deferral of payment may be more 
effective than risk adjustment in mitigating incentives to take hard-
to-measure risks (such as the risks of new activities or products, or 
certain risks such as reputational or operational risk that may be 
difficult to measure with respect to particular activities), especially 
if such risks are likely to be realized during the deferral period. 
Accordingly, in some cases two or more methods may be needed in 
combination for an incentive compensation arrangement to be balanced.
    The greater the potential incentives an arrangement creates for an 
employee to increase the risks associated with the employee's 
activities, the stronger the effect should be of the methods applied to 
achieve balance. Thus, for example, risk adjustments used to counteract 
a materially unbalanced compensation arrangement should have a 
similarly material impact on the incentive compensation paid under the 
arrangement. Further, improvements in the quality and reliability of 
performance measures themselves, for example improving the reliability 
and accuracy of estimates of revenues and profits upon which 
performance measures depend, can significantly improve the degree of 
balance in risk-taking incentives.
    Where judgment plays a significant role in the design or operation 
of an incentive compensation arrangement, strong policies and 
procedures, internal controls, and ex post monitoring of incentive 
compensation payments relative to actual risk outcomes are particularly 
important to help ensure that the arrangements as implemented are 
balanced and do not encourage imprudent risk-taking. For example, if a 
banking organization relies to a significant degree on the judgment of 
one or more managers to ensure that the incentive compensation awards 
to employees are appropriately risk-adjusted, the organization should 
have policies and procedures that describe how managers are expected to 
exercise that judgment to achieve balance and that provide for the 
manager(s) to receive appropriate available information about the 
employee's risk-taking activities to make informed judgments.
    Large banking organizations. Methods and practices for making 
compensation sensitive to risk are likely to evolve rapidly during the 
next few years, driven in part by the efforts of supervisors and other 
stakeholders. LBOs should actively monitor developments in the field 
and should incorporate into their incentive compensation systems new or 
emerging methods or practices that are likely to improve the 
organization's long-term financial well-being and safety and soundness.
     The manner in which a banking organization seeks to 
achieve balanced incentive compensation arrangements should be tailored 
to account for the differences between employees--including the 
substantial differences between senior executives and other employees--
as well as between banking organizations.
    Activities and risks may vary significantly both across banking 
organizations and across employees within a particular banking 
organization. For example, activities, risks, and incentive 
compensation practices may differ materially among banking 
organizations based on, among other things, the scope or complexity of 
activities conducted and the business strategies pursued by the 
organizations. These differences mean that methods for achieving 
balanced compensation arrangements at one organization may not be 
effective in restraining incentives to engage in imprudent risk-taking 
at another organization. Each organization is responsible for ensuring 
that its incentive compensation arrangements are consistent with the 
safety and soundness of the organization.
    Moreover, the risks associated with the activities of one group of 
non-executive employees (e.g., loan originators) within a banking 
organization may differ significantly from those of another group of 
non-executive employees (e.g., spot foreign exchange traders) within 
the organization. In addition, reliable quantitative measures of risk 
and risk outcomes are unlikely to be available for a banking 
organization as a whole, particularly a large, complex organization. 
This factor can make it difficult for banking organizations to achieve 
balanced compensation arrangements for senior executives who have 
responsibility for managing risks on an organization-wide basis solely 
through use of the risk-adjustment-of-award method.
    Furthermore, the payment of deferred incentive compensation in 
equity (such as restricted stock of the organization) or equity-based 
instruments (such as options to acquire the organization's stock) may 
be helpful in restraining the risk-taking incentives of senior 
executives and other covered employees whose activities may have a 
material effect on the overall financial performance of the 
organization. However, equity-related deferred compensation may not be 
as effective in restraining the incentives of lower-level covered 
employees (particularly at large organizations) to take risks because 
such

[[Page 36410]]

employees are unlikely to believe that their actions will materially 
affect the organization's stock price.
    Banking organizations should take account of these differences when 
constructing balanced compensation arrangements. For most banking 
organizations, the use of a single, formulaic approach to making 
employee incentive compensation arrangements appropriately risk-
sensitive is likely to result in arrangements that are unbalanced at 
least with respect to some employees.\15\
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    \15\ For example, spreading payouts of incentive compensation 
awards over a standard three-year period may not appropriately 
reflect the differences in the type and time horizon of risk 
associated with the activities of different groups of employees, and 
may not be sufficient by itself to balance the compensation 
arrangements of employees who may expose the organization to 
substantial longer-term risks.
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    Large banking organizations. Incentive compensation arrangements 
for senior executives at LBOs are likely to be better balanced if they 
involve deferral of a substantial portion of the executives' incentive 
compensation over a multi-year period in a way that reduces the amount 
received in the event of poor performance, substantial use of multi-
year performance periods, or both. Similarly, the compensation 
arrangements for senior executives at LBOs are likely to be better 
balanced if a significant portion of the incentive compensation of 
these executives is paid in the form of equity-based instruments that 
vest over multiple years, with the number of instruments ultimately 
received dependent on the performance of the organization during the 
deferral period.
    The portion of the incentive compensation of other covered 
employees that is deferred or paid in the form of equity-based 
instruments should appropriately take into account the level, nature, 
and duration of the risks that the employees' activities create for the 
organization and the extent to which those activities may materially 
affect the overall performance of the organization and its stock price. 
Deferral of a substantial portion of an employee's incentive 
compensation may not be workable for employees at lower pay scales 
because of their more limited financial resources. This may require 
increased reliance on other measures in the incentive compensation 
arrangements for these employees to achieve balance.
     Banking organizations should carefully consider the 
potential for ``golden parachutes'' and the vesting arrangements for 
deferred compensation to affect the risk-taking behavior of employees 
while at the organizations.
    Arrangements that provide for an employee (typically a senior 
executive), upon departure from the organization or a change in control 
of the organization, to receive large additional payments or the 
accelerated payment of deferred amounts without regard to risk or risk 
outcomes can provide the employee significant incentives to expose the 
organization to undue risk. For example, an arrangement that provides 
an employee with a guaranteed payout upon departure from an 
organization, regardless of performance, may neutralize the effect of 
any balancing features included in the arrangement to help prevent 
imprudent risk-taking.
    Banking organizations should carefully review any such existing or 
proposed arrangements (sometimes called ``golden parachutes'') and the 
potential impact of such arrangements on the organization's safety and 
soundness. In appropriate circumstances an organization should consider 
including balancing features--such as risk adjustment or deferral 
requirements that extend past the employee's departure--in the 
arrangements to mitigate the potential for the arrangements to 
encourage imprudent risk-taking. In all cases, a banking organization 
should ensure that the structure and terms of any golden parachute 
arrangement entered into by the organization do not encourage imprudent 
risk-taking in light of the other features of the employee's incentive 
compensation arrangements.
    Large banking organizations. Provisions that require a departing 
employee to forfeit deferred incentive compensation payments may weaken 
the effectiveness of the deferral arrangement if the departing employee 
is able to negotiate a ``golden handshake'' arrangement with the new 
employer.\16\ This weakening effect can be particularly significant for 
senior executives or other skilled employees at LBOs whose services are 
in high demand within the market.
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    \16\ Golden handshakes are arrangements that compensate an 
employee for some or all of the estimated, non-adjusted value of 
deferred incentive compensation that would have been forfeited upon 
departure from the employee's previous employment.
---------------------------------------------------------------------------

    Golden handshake arrangements present special issues for LBOs and 
supervisors. For example, while a banking organization could adjust its 
deferral arrangements so that departing employees will continue to 
receive any accrued deferred compensation after departure (subject to 
any clawback or malus \17\), these changes could reduce the employee's 
incentive to remain at the organization and, thus, weaken an 
organization's ability to retain qualified talent, which is an 
important goal of compensation, and create conflicts of interest. 
Moreover, actions of the hiring organization (which may or may not be a 
supervised banking organization) ultimately may defeat these or other 
risk-balancing aspects of a banking organization's deferral 
arrangements. LBOs should monitor whether golden handshake arrangements 
are materially weakening the organization's efforts to constrain the 
risk-taking incentives of employees. The Agencies will continue to work 
with banking organizations and others to develop appropriate methods 
for addressing any effect that such arrangements may have on the safety 
and soundness of banking organizations.
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    \17\ A malus arrangement permits the employer to prevent vesting 
of all or part of the amount of a deferred remuneration award. Malus 
provisions are invoked when risk outcomes are worse than expected or 
when the information upon which the award was based turns out to 
have been incorrect. Loss of unvested compensation due to the 
employee voluntarily leaving the firm is not an example of malus as 
the term is used in this guidance.
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     Banking organizations should effectively communicate to 
employees the ways in which incentive compensation awards and payments 
will be reduced as risks increase.
    In order for the risk-sensitive provisions of incentive 
compensation arrangements to affect employee risk-taking behavior, the 
organization's employees need to understand that the amount of 
incentive compensation that they may receive will vary based on the 
risk associated with their activities. Accordingly, banking 
organizations should ensure that employees covered by an incentive 
compensation arrangement are informed about the key ways in which risks 
are taken into account in determining the amount of incentive 
compensation paid. Where feasible, an organization's communications 
with employees should include examples of how incentive compensation 
payments may be adjusted to reflect projected or actual risk outcomes. 
An organization's communications should be tailored appropriately to 
reflect the sophistication of the relevant audience(s).
Principle 2: 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.

[[Page 36411]]

    In order to increase their own compensation, employees may seek to 
evade the processes established by a banking organization to achieve 
balanced compensation arrangements. Similarly, an employee covered by 
an incentive compensation arrangement may seek to influence, in ways 
designed to increase the employee's pay, the risk measures or other 
information or judgments that are used to make the employee's pay 
sensitive to risk.
    Such actions may significantly weaken the effectiveness of an 
organization's incentive compensation arrangements in restricting 
imprudent risk-taking. These actions can have a particularly damaging 
effect on the safety and soundness of the organization if they result 
in the weakening of risk measures, information, or judgments that the 
organization uses for other risk-management, internal control, or 
financial purposes. In such cases, the employee's actions may weaken 
not only the balance of the organization's incentive compensation 
arrangements, but also the risk-management, internal controls, and 
other functions that are supposed to act as a separate check on risk-
taking. For this reason, traditional risk-management controls alone do 
not eliminate the need to identify employees who may expose the 
organization to material risk, nor do they obviate the need for the 
incentive compensation arrangements for these employees to be balanced. 
Rather, a banking organization's risk-management processes and internal 
controls should reinforce and support the development and maintenance 
of balanced incentive compensation arrangements.
     Banking organizations should have appropriate controls to 
ensure that their processes for achieving balanced compensation 
arrangements are followed and to maintain the integrity of their risk-
management and other functions.
    To help prevent damage from occurring, a banking organization 
should have strong controls governing its process for designing, 
implementing, and monitoring incentive compensation arrangements. 
Banking organizations should create and maintain sufficient 
documentation to permit an audit of the effectiveness of the 
organization's processes for establishing, modifying, and monitoring 
incentive compensation arrangements. Smaller banking organizations 
should incorporate reviews of these processes into their overall 
framework for compliance monitoring (including internal audit).
    Large banking organizations. LBOs should have and maintain policies 
and procedures that (i) identify and describe the role(s) of the 
personnel, business units, and control units authorized to be involved 
in the design, implementation, and monitoring of incentive compensation 
arrangements; (ii) identify the source of significant risk-related 
inputs into these processes and establish appropriate controls 
governing the development and approval of these inputs to help ensure 
their integrity; and (iii) identify the individual(s) and control 
unit(s) whose approval is necessary for the establishment of new 
incentive compensation arrangements or modification of existing 
arrangements.
    An LBO also should conduct regular internal reviews to ensure that 
its processes for achieving and maintaining balanced incentive 
compensation arrangements are consistently followed. Such reviews 
should be conducted by audit, compliance, or other personnel in a 
manner consistent with the organization's overall framework for 
compliance monitoring. An LBO's internal audit department also should 
separately conduct regular audits of the organization's compliance with 
its established policies and controls relating to incentive 
compensation arrangements. The results should be reported to 
appropriate levels of management and, where appropriate, the 
organization's board of directors.
     Appropriate personnel, including risk-management 
personnel, should have input into the organization's processes for 
designing incentive compensation arrangements and assessing their 
effectiveness in restraining imprudent risk-taking.
    Developing incentive compensation arrangements that provide 
balanced risk-taking incentives and monitoring arrangements to ensure 
they achieve balance over time requires an understanding of the risks 
(including compliance risks) and potential risk outcomes associated 
with the activities of the relevant employees. Accordingly, banking 
organizations should have policies and procedures that ensure that 
risk-management personnel have an appropriate role in the 
organization's processes for designing incentive compensation 
arrangements and for assessing their effectiveness in restraining 
imprudent risk-taking.\18\ Ways that risk managers might assist in 
achieving balanced compensation arrangements include, but are not 
limited to, (i) reviewing the types of risks associated with the 
activities of covered employees; (ii) approving the risk measures used 
in risk adjustments and performance measures, as well as measures of 
risk outcomes used in deferred-payout arrangements; and (iii) analyzing 
risk-taking and risk outcomes relative to incentive compensation 
payments.
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    \18\ Involvement of risk-management personnel in the design and 
monitoring of these arrangements also should help ensure that the 
organization's risk-management functions can properly understand and 
address the full range of risks facing the organization.
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    Other functions within an organization, such as its control, human 
resources, or finance functions, also play an important role in helping 
ensure that incentive compensation arrangements are balanced. For 
example, these functions may contribute to the design and review of 
performance measures used in compensation arrangements or may supply 
data used as part of these measures.
     Compensation for employees in risk-management and control 
functions should be sufficient to attract and retain qualified 
personnel and should avoid conflicts of interest.
    The risk-management and control personnel involved in the design, 
oversight, and operation of incentive compensation arrangements should 
have appropriate skills and experience needed to effectively fulfill 
their roles. These skills and experiences should be sufficient to equip 
the personnel to remain effective in the face of challenges by covered 
employees seeking to increase their incentive compensation in ways that 
are inconsistent with sound risk-management or internal controls. The 
compensation arrangements for employees in risk-management and control 
functions thus should be sufficient to attract and retain qualified 
personnel with experience and expertise in these fields that is 
appropriate in light of the size, activities, and complexity of the 
organization.
    In addition, to help preserve the independence of their 
perspectives, the incentive compensation received by risk-management 
and control personnel staff should not be based substantially on the 
financial performance of the business units that they review. Rather, 
the performance measures used in the incentive compensation 
arrangements for these personnel should be based primarily on the 
achievement of the objectives of their functions (e.g., adherence to 
internal controls).
     Banking organizations should monitor the performance of 
their incentive compensation arrangements and should revise the 
arrangements as needed if payments do not appropriately reflect risk.
    Banking organizations should monitor incentive compensation awards 
and payments, risks taken, and actual risk outcomes to determine 
whether

[[Page 36412]]

incentive compensation payments to employees are reduced to reflect 
adverse risk outcomes or high levels of risk taken. Results should be 
reported to appropriate levels of management, including the board of 
directors where warranted and consistent with Principle 3 below. The 
monitoring methods and processes used by a banking organization should 
be commensurate with the size and complexity of the organization, as 
well as its use of incentive compensation. Thus, for example, a small, 
noncomplex organization that uses incentive compensation only to a 
limited extent may find that it can appropriately monitor its 
arrangements through normal management processes.
    A banking organization should take the results of such monitoring 
into account in establishing or modifying incentive compensation 
arrangements and in overseeing associated controls. If, over time, 
incentive compensation paid by a banking organization does not 
appropriately reflect risk outcomes, the organization should review and 
revise its incentive compensation arrangements and related controls to 
ensure that the arrangements, as designed and implemented, are balanced 
and do not provide employees incentives to take imprudent risks.
Principle 3: 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.
    Given the key role of senior executives in managing the overall 
risk-taking activities of an organization, the board of directors of a 
banking organization should directly approve the incentive compensation 
arrangements for senior executives.\19\ The board also should approve 
and document any material exceptions or adjustments to the incentive 
compensation arrangements established for senior executives and should 
carefully consider and monitor the effects of any approved exceptions 
or adjustments on the balance of the arrangement, the risk-taking 
incentives of the senior executive, and the safety and soundness of the 
organization.
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    \19\ As used in this guidance, the term ``board of directors'' 
is used to refer to the members of the board of directors who have 
primary responsibility for overseeing the incentive compensation 
system. Depending on the manner in which the board is organized, the 
term may refer to the entire board of directors, a compensation 
committee of the board, or another committee of the board that has 
primary responsibility for overseeing the incentive compensation 
system. In the case of FBOs, the term refers to the relevant 
oversight body for the firm's U.S. operations, consistent with the 
FBO's overall corporate and management structure.
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    The board of directors of an organization also is ultimately 
responsible for ensuring that the organization's incentive compensation 
arrangements for all covered employees are appropriately balanced and 
do not jeopardize the safety and soundness of the organization. The 
involvement of the board of directors in oversight of the 
organization's overall incentive compensation program should be scaled 
appropriately to the scope and prevalence of the organization's 
incentive compensation arrangements.
    Large banking organizations and organizations that are significant 
users of incentive compensation. The board of directors of an LBO or 
other banking organization that uses incentive compensation to a 
significant extent should actively oversee the development and 
operation of the organization's incentive compensation policies, 
systems, and related control processes. The board of directors of such 
an organization should review and approve the overall goals and 
purposes of the organization's incentive compensation system. In 
addition, the board should provide clear direction to management to 
ensure that the goals and policies it establishes are carried out in a 
manner that achieves balance and is consistent with safety and 
soundness.
    The board of directors of such an organization also should ensure 
that steps are taken so that the incentive compensation system--
including performance measures and targets--is designed and operated in 
a manner that will achieve balance.
     The board of directors should monitor the performance, and 
regularly review the design and function, of incentive compensation 
arrangements.
    To allow for informed reviews, the board should receive data and 
analysis from management or other sources that are sufficient to allow 
the board to assess whether the overall design and performance of the 
organization's incentive compensation arrangements are consistent with 
the organization's safety and soundness. These reviews and reports 
should be appropriately scoped to reflect the size and complexity of 
the banking organization's activities and the prevalence and scope of 
its incentive compensation arrangements.
    The board of directors of a banking organization should closely 
monitor incentive compensation payments to senior executives and the 
sensitivity of those payments to risk outcomes. In addition, if the 
compensation arrangement for a senior executive includes a clawback 
provision, then the review should include sufficient information to 
determine if the provision has been triggered and executed as planned.
    The board of directors of a banking organization should seek to 
stay abreast of significant emerging changes in compensation plan 
mechanisms and incentives in the marketplace as well as developments in 
academic research and regulatory advice regarding incentive 
compensation policies. However, the board should recognize that 
organizations, activities, and practices within the industry are not 
identical. Incentive compensation arrangements at one organization may 
not be suitable for use at another organization because of differences 
in the risks, controls, structure, and management among organizations. 
The board of directors of each organization is responsible for ensuring 
that the incentive compensation arrangements for its organization do 
not encourage employees to take risks that are beyond the 
organization's ability to manage effectively, regardless of the 
practices employed by other organizations.
    Large banking organizations and organizations that are significant 
users of incentive compensation. The board of an LBO or other 
organization that uses incentive compensation to a significant extent 
should receive and review, on an annual or more frequent basis, an 
assessment by management, with appropriate input from risk-management 
personnel, of the effectiveness of the design and operation of the 
organization's incentive compensation system in providing risk-taking 
incentives that are consistent with the organization's safety and 
soundness. These reports should include an evaluation of whether or how 
incentive compensation practices may increase the potential for 
imprudent risk-taking.
    The board of such an organization also should receive periodic 
reports that review incentive compensation awards and payments relative 
to risk outcomes on a backward-looking basis to determine whether the 
organization's incentive compensation arrangements may be promoting 
imprudent risk-taking. Boards of directors of these organizations also 
should consider periodically obtaining and reviewing simulation 
analysis of compensation on a forward-looking basis based on a range of 
performance levels, risk outcomes, and the amount of risks taken.

[[Page 36413]]

     The organization, composition, and resources of the board 
of directors should permit effective oversight of incentive 
compensation.
    The board of directors of a banking organization should have, or 
have access to, a level of expertise and experience in risk-management 
and compensation practices in the financial services industry that is 
appropriate for the nature, scope, and complexity of the organization's 
activities. This level of expertise may be present collectively among 
the members of the board, may come from formal training or from 
experience in addressing these issues, including as a director, or may 
be obtained through advice received from outside counsel, consultants, 
or other experts with expertise in incentive compensation and risk-
management. The board of directors of an organization with less complex 
and extensive incentive compensation arrangements may not find it 
necessary or appropriate to require special board expertise or to 
retain and use outside experts in this area.
    In selecting and using outside parties, the board of directors 
should give due attention to potential conflicts of interest arising 
from other dealings of the parties with the organization or for other 
reasons. The board also should exercise caution to avoid allowing 
outside parties to obtain undue levels of influence. While the 
retention and use of outside parties may be helpful, the board retains 
ultimate responsibility for ensuring that the organization's incentive 
compensation arrangements are consistent with safety and soundness.
    Large banking organizations and organizations that are significant 
users of incentive compensation. If a separate compensation committee 
is not already in place or required by other authorities,\20\ the board 
of directors of an LBO or other banking organization that uses 
incentive compensation to a significant extent should consider 
establishing such a committee--reporting to the full board--that has 
primary responsibility for overseeing the organization's incentive 
compensation systems. A compensation committee should be composed 
solely or predominantly of non-executive directors. If the board does 
not have such a compensation committee, the board should take other 
steps to ensure that non-executive directors of the board are actively 
involved in the oversight of incentive compensation systems. The 
compensation committee should work closely with any board-level risk 
and audit committees where the substance of their actions overlap.
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    \20\ See, New York Stock Exchange Listed Company Manual Section 
303A.05(a); Nasdaq Listing Rule 5605(d); Internal Revenue Code 
section 162(m) (26 U.S.C. 162(m)).
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     A banking organization's disclosure practices should 
support safe and sound incentive compensation arrangements.
    If a banking organization's incentive compensation arrangements 
provide employees incentives to take risks that are beyond the 
tolerance of the organization's shareholders, these risks are likely to 
also present a risk to the safety and soundness of the 
organization.\21\ To help promote safety and soundness, a banking 
organization should provide an appropriate amount of information 
concerning its incentive compensation arrangements for executive and 
non-executive employees and related risk-management, control, and 
governance processes to shareholders to allow them to monitor and, 
where appropriate, take actions to restrain the potential for such 
arrangements and processes to encourage employees to take imprudent 
risks. Such disclosures should include information relevant to 
employees other than senior executives. The scope and level of the 
information disclosed by the organization should be tailored to the 
nature and complexity of the organization and its incentive 
compensation arrangements.\22\
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    \21\ On the other hand, as noted previously, compensation 
arrangements that are in the interests of the shareholders of a 
banking organization are not necessarily consistent with safety and 
soundness.
    \22\ A banking organization also should comply with the 
incentive compensation disclosure requirements of the Federal 
securities law and other laws as applicable. See, e.g., Proxy 
Disclosure Enhancements, SEC Release Nos. 33-9089, 34-61175, 74 FR 
68334 (Dec. 23, 2009) (to be codified at 17 CFR pts. 229 and 249).
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     Large banking organizations should follow a systematic 
approach to developing a compensation system that has balanced 
incentive compensation arrangements.
    At banking organizations with large numbers of risk-taking 
employees engaged in diverse activities, an ad hoc approach to 
developing balanced arrangements is unlikely to be reliable. Thus, an 
LBO should use a systematic approach--supported by robust and 
formalized policies, procedures, and systems--to ensure that those 
arrangements are appropriately balanced and consistent with safety and 
soundness. Such an approach should provide for the organization 
effectively to:
    [cir] Identify employees who are eligible to receive incentive 
compensation and whose activities may expose the organization to 
material risks. These employees should include (i) senior executives 
and others who are responsible for oversight of the organization's 
firm-wide activities or material business lines; (ii) individual 
employees, including non-executive employees, whose activities may 
expose the organization to material amounts of risk; and (iii) 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;
    [cir] Identify the types and time horizons of risks to the 
organization from the activities of these employees;
    [cir] Assess the potential for the performance measures included in 
the incentive compensation arrangements for these employees to 
encourage the employees to take imprudent risks;
    [cir] Include balancing elements, such as risk adjustments or 
deferral periods, within the incentive compensation arrangements for 
these employees that are reasonably designed to ensure that the 
arrangement will be balanced in light of the size, type, and time 
horizon of the inherent risks of the employees' activities;
    [cir] Communicate to the employees the ways in which their 
incentive compensation awards or payments will be adjusted to reflect 
the risks of their activities to the organization; and
    [cir] Monitor incentive compensation awards, payments, risks taken, 
and risk outcomes for these employees and modify the relevant 
arrangements if payments made are not appropriately sensitive to risk 
and risk outcomes.
III. Conclusion
    Banking organizations are responsible for ensuring that their 
incentive compensation arrangements do not encourage imprudent risk-
taking behavior and are consistent with the safety and soundness of the 
organization. The Agencies expect banking organizations to take prompt 
action to address deficiencies in their incentive compensation 
arrangements or related risk-management, control, and governance 
processes.
    The Agencies intend to actively monitor the actions taken by 
banking organizations in this area and will promote further advances in 
designing and implementing balanced incentive compensation 
arrangements. Where appropriate, the Agencies will take supervisory or 
enforcement action to ensure that material deficiencies that pose a 
threat to the safety and soundness of the organization are promptly 
addressed. The Agencies also

[[Page 36414]]

will update this guidance as appropriate to incorporate best practices 
as they develop over time.
    This concludes the text of the Guidance on Sound Incentive 
Compensation Policies.

    Dated: June 17, 2010.
John C. Dugan,
Comptroller of the Currency.
    By order of the Board of Governors of the Federal Reserve 
System, June 21, 2010.
Robert deV. Frierson,
Deputy Secretary of the Board.
    Dated: June 21, 2010.
Valerie J. Best,
Assistant Executive Secretary, Federal Deposit Insurance Corporation.
    Dated: June 10, 2010.
    By the Office of Thrift Supervision.
John E. Bowman,
Acting Director.
[FR Doc. 2010-15435 Filed 6-24-10; 8:45 am]
BILLING CODE 6210-01-P 4810-33-P 6714-01-P 6720-01-P