Federal Reserve Issues Final Guidance on Risks & Incentive Pay

Yesterday, the U.S. Federal Reserve along with the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation and the Office of Thrift Supervision issued their final guidance on incentive compensation for financial institutions. This final guidance is based on proposed guidance issued in October 2009 and a series of incentive compensation reviews by the Federal Reserve and the other supervisory agencies. The agencies will conduct a second round of reviews later this year to evaluate the financial institutions compliance with the new guidance. Here is what the Federal Reserve had to say about their next steps.

"Many large banking organizations have already implemented some changes in their incentive compensation policies, but more work clearly needs to be done," Federal Reserve Governor Daniel K. Tarullo said. "The Federal Reserve expects firms to make material progress this year on the matters identified as we work toward the ultimate goal of ensuring that incentive compensation programs are risk appropriate and are supported by strong corporate governance."

During the next stage, the banking agencies will be conducting additional cross-firm, horizontal reviews of incentive compensation practices at the large, complex banking organizations for employees in certain business lines, such as mortgage originators. The agencies will also be following up on specific areas that were found to be deficient at many firms, such as:

• Many firms need better ways to identify which employees, either individually or as a group, can expose banking organizations to material risk;


• While many firms are using or are considering various methods to make incentive compensation more risk sensitive, many are not fully capturing the risks involved and are not applying such methods to enough employees;


• Many firms are using deferral arrangements to adjust for risk, but they are taking a "one-size-fits-all" approach and are not tailoring these deferral arrangements according to the type or duration of risk; and


• Many firms do not have adequate mechanisms to evaluate whether established practices are successful in balancing risk.

In addition to the work with the large, complex banking organizations, the agencies are also working to incorporate oversight of incentive compensation arrangements into the regular examination process for smaller firms. These reviews are being tailored to take account of the size, complexity, and other characteristics of these banking organizations.

Having a solid understanding of your risk profile and the resulting impact of incentive programs is now critical for financial institutions as well as companies in other industries. Wheelhouse Advisors can help you develop stronger incentive programs with a thorough analysis of your risks.  To learn more, visit www.WheelhouseAdvisors.com.