By Ray Birch
WASHINGTON—How will the incentive-based comp proposal impact the only credit union to fall into one of the rule’s more stringent oversight categories? And what about new compensation rules for management at smaller CUs?
Analysts say they can’t state specifically how the $75-billion Navy FCU, a “Level 2” institution under the proposal, will be affected. But experts say that while the rules were driven by the excesses of bank compensation programs, that credit union comp plans tend not to encourage inappropriate risk by the organization, and don’t often involve equity compensation—targets of the rule.
The rule’s authors—NCUA, FDIC, Federal Housing Finance Agency, Federal Reserve, OCC, and the Securities and Exchange Commission—clarified risk taking as excessive compensation or incentives that could lead to a material financial loss.
Without the ability to review Navy’s executive comp plans, experts speculate that the rules may do little more than require the Vienna, Va.-based CU to perform additional recordkeeping—annually document the structure of incentive-based compensation arrangements already in place.
Navy FCU did not return calls from CUToday.info regarding the proposal.
Rule Categories
Dan Kleinman
The incentive compensation rules would apply to covered financial institutions with total assets of $1 billion or more. Those less than $1 billion are exempt. Covered institutions would be divided into three categories:
- Level 1: institutions with assets of $250 billion and above.
- Level 2: institutions with assets of $50 billion to $250 billion.
- Level 3: institutions with assets of $1 billion to $50 billion.
Section 956 of the Dodd-Frank Wall Street Reform and Consumer Protection Act requires the agencies to jointly prescribe the regulations or guidelines. The agencies stated in a joint release there is evidence that flawed incentive-based compensation packages in the financial industry were one of the contributing factors in the financial crisis that began in 2007.
Much of the proposed rules would address requirements for senior executive officers and employees who are significant risk-takers at Level 1 and Level 2 institutions. All institutions that would be covered by the proposed rules would be required to annually document the structure of incentive-based compensation arrangements and retain those records for seven years. Boards of directors of covered institutions would be required to conduct oversight of the arrangements.
Dan Kleinman, owner of San Francisco-based Kleinman Consulting, which designs and audits compensation programs for a variety of industries nationally, said each of the federal agencies has come up with its own iteration of the rule and addressed how the rule will apply to their regulated institutions. He noted that Level 1 and Level 2 rules are more stringent than Level 3.
7-Year Clawback
Kleinman explained that under the proposal, for Level 2 institutions NCUA has proposed that the three-year deferral of variable incentives move to four—meaning executives would now have to wait four years to realize one-half of the amount of their variable compensation. The clawback provision—forfeiting any variable compensation that was paid using criteria that was later found to be detrimental to membership’s financial interests—is proposed to cover a seven-year look-back period.
“Most well-managed companies that have sound incentive plans already have these features in them,” said Kleinman.
Kleinman said, too, that current plans that can be shown to compensate competitively with similar sized and structured organizations have little to worry about with regard to being considered excessive. “Already established incentive plans will be grandfathered under the proposed regulations and not subject to its scrutiny,” he said.
If a Level 3 or Level 2 credit union decides to create a new comp plan and put it into effect, the rules apply.
“Deferral then could be done on a prorated basis over four years, or could be done in a cliff fashion where the executive gets the rest of their deferred money in four years,” said Kleinman. “There will be some issues in terms of what to do with the money while it is sitting there: Can it be invested? Can something happen to it?”
Kleinman emphasized that there may not be a great deal for Navy, and also credit unions that fall into the Level 3 tier, to worry about with the new rules.
Michael Moebs, Moebs $ervices
“Most credit unions do not deal with equity plans,” said Kleinman. “Equity plans are a whole different ballgame and credit unions tend not to be involved with equity compensation—to their betterment. So what I am saying is these new rules, for Navy and for most credit unions, could be much to do about nothing. Navy could look at this and say, ‘OK, we are going to have to do some more reporting, and that might cost a little more money. But hopefully our systems are capable of collecting the data so we can effectively report on our compensation plans and do so in a less laborious fashion.
“As long as credit unions don’t go out and create some new type of incentive plan that could be interpreted as egregious; as long as their compensation plan guidelines and goals don’t adversely affect their organizations financially, there is no real concern here,” said Kleinman.
Kleinman added that the rules extend beyond plans to just executives, and also to any area that collectively could have large impact on the financial viability of the organization, such as loan officers.
Mortgage Crisis
Michael Moebs, economist and CEO at Meobs $ervices in Lake Forest, Ill., said the new comp rules emanated from the Bank of America purchase of Merrill Lynch—to save the security firm at the time of the meltdown of Lehman Brothers, which had followed the meltdown of Bear Stearns earlier in 2008.
“This was all precipitated by the mortgage bubble,” Moebs reminded. “In the Merrill Lynch purchase the executives of Merrill Lynch received an extraordinary large bonus even though Merrill Lynch was illiquid and in seriously bad shape. The Dodd Frank Act tried to curb practices like this in a future severe financial crisis.”
Moebs asserted that for CUs the compensation issues lie not with the larger organizations, but with mid-size to smaller credit unions.
“Often the board of directors of community banks and credit unions are pressured into compensation plans for fear of losing an executive who might take a while to replace and the process of replacement of an executive is often costly,” said Moebs.