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At the Wednesday March 2 Open Meeting, the Securities and
Exchange Commission voted to approve a new rule that would affect incentive compensation
paid to employees of investment advisers and broker-dealers. Commissioners
Casey and Paredes voted against proposing the rule as drafted. The other three
voted to move the proposed rule into the comment period.
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
(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
A "covered financial institution" includes investment
advisers (as defined under section 202(a)(11)
of the Investment Advisers Act), a broker-dealer registered under section
15 of the Securities Exchange Act of 1934, as well as banks, credit unions,
FNMA, FHLMC and others designated by regulators, with assets of $1 billion of
If you are a private fund manager and have assets of $1
billion or more under management, then this rule would affect you. As drafted
the rule applies if you are an investment adviser, regardless of whether you
are registered with the SEC as an investment adviser.
Some real estate fund managers are still looking for
exemptions for registering with the SEC or registering with the state based on
calculation, or by taking the position that they are not a "private fund"
under the SEC's definition. The choice of registration would not affect the
applicability of this proposed rule.
This is a joint rulemaking so there needs to be some
consistency across financial institutions. A draft of the proposal was
published by the FDIC (pdf).
Only incentive-based compensation paid to "covered
persons" would be subject to the requirements of this Proposed Rule. A "covered
person" would be any executive officer, employee, director, or principal
shareholder of a covered financial institution.
The proposed rule defines "incentive-based compensation"
to mean any variable compensation that serves as an incentive for performance.
It excludes fixed salary.
The first requirement is that a covered financial
institution must submit an annual report "disclosing the structure of its
incentive-based compensation arrangements that is sufficient to determine
whether the incentive-based compensation structure provides covered employees
with excessive compensation, fees, or benefits, or could lead to material
financial loss to the covered financial institution." The report must contain:
(1) A 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 apply;
(2) A succinct description of the covered financial
institution's policies and procedures governing its incentive-based
(3) For larger covered financial institutions, a succinct
description of any specific incentive compensation policies and procedures for
the institution's executive officers, and other covered persons who the board
or a committee thereof determines individually have the ability to expose the
institution to possible losses that are substantial in relation to the
institution's size, capital, or overall risk tolerance;
(4) Any 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 was
(5) The specific reasons the covered financial
institution believes the structure of its incentive-based compensation plan
does not provide covered persons incentives to engage in behavior that is
likely to cause the covered financial institution to suffer a material
financial loss, and does not provide covered persons with excessive
Under the SEC proposal, there would be a mandatory
deferral of incentive compensation for employees of large financial
institutions (over $50 billion). At least 50% of the incentive compensation
must be paid over three years. It sounded like this deferral requirement was
the point most disliked by the two dissenting commissioners.
This is a fairly ugly rule for private equity funds and
real estate funds. Incentive compensation is usually paid upon the realization
of the assets.
Under Dodd-Frank, the rule is required to be in place 9
months after enactment. That would mean an April 21, 2011 deadline.
additional commentary on developments in compliance and ethics, visit Compliance Building,
a blog hosted by Doug Cornelius.
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