Summary of Federal Reserve's Proposed Guidance on Sound Incentive Compensation Practices

    23 October 2009

    Highlights

    • All Federal Reserve member organizations must evaluate their incentive compensation arrangements and related risk management, control, and corporate governance processes and immediately address deficiencies in such arrangements or processes that are inconsistent with safety and soundness. 
    • Because incentive compensation arrangements for executive and non-executive employees may pose safety and soundness risks if not properly structured, the proposed guidance applies to senior executives as well as other employees who, either individually or as part of a group, may expose the organization to material risks. 
    • 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. Employees may be particularly motivated to take excessive risk in order to reach performance targets that are aggressive, but potentially achievable. 
    • The required review of policies, procedures, and systems implemented by a small banking organization (assets < $175mm) using incentive compensation arrangements on a limited basis will be substantially less extensive, formalized, and detailed than the review required for a large, complex banking organization that uses incentive compensation arrangements extensively. 
    • Supervisory findings on incentive compensation practices will be included in an organization’s annual report/examination or inspection, and reflected in its supervisory ratings. 
      • Enforcement action is possible if an organization’s incentive compensation arrangements or related risk management, control, or governance processes pose a risk to the safety and soundness of the organization and such deficiencies are not cured promptly. 
    • The Federal Reserve will work with the Securities and Exchange Commission (“SEC”) to improve the disclosures provided by public banking organizations in ways that promote the safety and soundness of these organizations.