There is a new joint federal rule in the works for all
financial institutions. This will lump together banks, credit unions,
broker-dealers and investment advisers. If you have more than $1 billion in
assets under management, you need to pay attention to this rule.
956 of the Dodd-Frank Wall Street Reform and Consumer Protection Act
requires federal regulators to "prescribe regulations or guidelines to require
each covered financial institution to disclose to the appropriate Federal
regulator the structures of all incentive-based compensation arrangements
offered by such covered financial institutions sufficient to determine whether
the compensation structure:
(A) provides an executive officer, employee, director, or
principal shareholder of the bank holding company with covered financial
institution with excessive compensation, fees, or benefits; or
(B) could lead to material financial loss to the covered
The proposed rule is tied to the proposed method of calculation
for the investment advisers and private fund managers released in November 2010.
Unfortunately, the Form ADV in that proposed rule has not yet been finalized,
so we don't know exactly how that assets under management will be calculated.
Assuming there are not big changes to the new Form ADV, if your fund assets
plus uncalled capital commitments are in excess of $1 billion, then you are a
"covered financial institution.
If you are a "covered financial institution" then you
must submit a new report to the SEC. In that report you will need to describe
the structure of your incentive-based compensation arrangements and whether they
provide for excessive compensation or could lead to to material financial loss.
This report must include the following:
clear narrative description of the components of the covered financial
institution's incentive-based compensation arrangements applicable to
covered persons and specifying the types of covered persons to which they
succinct description of the covered financial institution's policies and
procedures governing its incentive-based compensation arrangements for
the covered financial institution has total consolidated assets of $50
billion or more, an additional succinct description of incentive-based
compensation policies and procedures specific to the covered financial
(i) Executive officers; and
(ii) Other covered persons who the board of directors, or a committee
thereof, of the covered financial institution has identified and
determined under §248.205(b)(3)(ii) of subpart C of this part individually
have the ability to expose the covered financial institution to possible
losses that are substantial in relation to the covered financial
institution's size, capital, or overall risk tolerance;
material changes to the covered financial institution's incentive-based
compensation arrangements and policies and procedures made since the
covered financial institution's last report submitted under paragraph (a)
of this section; and
specific reasons why the covered financial institution believes the
structure of its incentive-based compensation plan does not encourage
inappropriate risks by the covered financial institution by providing
covered persons with:
(i) Excessive compensation; or
(ii) Incentive-based compensation that could lead to a material financial
loss to the covered financial institution.
"Covered person" means any executive officer, employee,
director, or principal shareholder of a covered financial institution.
According to the SEC's Office of Risk, Strategy and
Financial Innovation there are about 132 broker-dealers with assets of
$1billion or more and 18 with assets in excess of $50 billions. Since
investment advisers do not currently report their assets so the SEC lacks hard
numbers. They estimated that about 70 investment advisers meet the $1 billion
asset threshold and only about 10 would be large enough to get hit by the
proposed bonus retention rules. (see page 70 of the proposed
I assume that the investment adviser counts do not take
into account the thousands of hedge fund, private equity fund and real estate
fund managers who will be registering with the SEC in the next few months.
The rule will not require a report on the actual
compensation. But it does try to limit incentive-based compensation that is
"unreasonable or disproportionate to the services performed."
For private equity funds, this should just be a paperwork
issue and not a substantive issue. Since private equity funds pay most of their
performance based on the final realization of assets in the fund, there are
generally few short-term incentives. Private equity fund managers get their
incentive pay when their investors get paid.
Nevertheless, this rule will be a headache for registered
private fund managers.
The rule has not yet been officially published by the
SEC. They are waiting for the other federal regulators to formally approve the
additional commentary on developments in compliance and ethics, visit Compliance Building,
a blog hosted by Doug Cornelius.
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