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James E. Earle Esq. and Mark D. Perlow Esq.
On March 30, 2011, seven federal financial regulators
(each, an "Agency," and collectively, the "Agencies")
published a proposed rule (the "Proposed Rule") that would
implement Section 956 of the Dodd-Frank Wall Street Reform and Consumer
Protection Act (the "Act").
Section 956 of the Act requires the Agencies to issue joint regulations that
prohibit "covered financial institutions" from entering into
incentive-based compensation arrangements that encourage inappropriate risks,
either because they provide certain covered persons of the covered financial
institutions with excessive compensation, or because they could lead to
material financial loss to the covered financial institution. Under Section
956, the regulations must also require covered financial institutions to
disclose the structures of their incentive-based compensation arrangements in a
manner sufficient to determine whether the foregoing prohibitions are being
Section 956 defines "covered financial institutions" to include a
broad range of financial institutions, including investment advisers and
registered broker-dealers that have $1 billion or more in total consolidated
assets (as opposed to assets under management). Section 956 also requires the
Agencies to ensure that their proposed regulations (i) are comparable to the
safety and soundness standards applicable to insured depository institutions
under Section 39 of the Federal Deposit Insurance Act (the "FDIA")
and (ii) take into consideration the compensation standards described in FDIA
While many banking institutions have recently been subjected to guidance on
sound incentive compensation policies adopted by certain Federal banking agencies
(the "Banking Agency Guidance"), 3
Section 956 applies, and the Proposed Rule would apply, to a broader range of
financial institutions. The Proposed Rule, however, will supplement, not
replace, other rules on compensation practices (including the Banking Agency
A forty-five day comment period will commence after the Proposed Rule is
published in the Federal Register, which should occur shortly after March 30.
Following the comment period, the Agencies will adopt a final rule which is
expected to become effective six months after its publication in the Federal
Register. This could mean an effective date for final rule sometime in late
2011 or early 2012.
The scope of the Proposed Rule is potentially very broad. The Agencies
collectively estimate that there are over 1,600 covered financial institutions
that will be subject to the Proposed Rule. Among those, the SEC estimates that
the Proposed Rule could cover up to 200 broker-dealers and investment advisers.
Moreover, the Proposed Rule generally follows a principles-based approach to
rulemaking and includes a number of critical undefined terms. Much of the
actual impact will therefore depend on how each Agency chooses to enforce its
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James E. Earle is a
partner in the Charlotte office of K&L Gates. A significant portion of Mr.
Earle's practice involves counseling publicly traded companies and other
complex employers on matters related to executive compensation. Clients include
financial services companies, hedge funds, large national retailers,
manufacturers and service-companies with global operations.
Mark D. Perlow is a partner
in the San Francisco office of K&L Gates. His practice focuses on
investment management and securities law. He regularly represents mutual funds,
hedge fund managers, investment advisers, fund boards of directors, and
broker-dealers on a variety of regulatory and transactional matters.