Sounds racy doesn’t it, like something you might say at a cocktail party to impress people (unsuccessfully)? Unfortunately for those affected, being labeled a “significant risk-taker” in the new proposed rules under Dodd-Frank Act Section 956 just means you are subject to a mandatory compensation “deferral” period during which up to 50% of your incentive-based compensation is subject to forfeiture or “downward adjustment” (and after that, the compensation is subject to a clawback!). The definition of “significant risk-taker” in the proposed rule is 20 pages long. It is intended to include “covered persons” (defined below) who are not “senior executive officers” (defined below) but are in the position to put a Level 1 or Level 2 covered institution at risk of material financial loss.
Only a covered person who receives annual base salary and incentive-based compensation of which at least one-third is incentive-based compensation (the “one-third threshold”) is eligible to be characterized as a “significant risk-taker.” The one-third threshold is based on the covered person’s annual base salary paid and incentive-based compensation “awarded” during the last calendar year that ended at least 180 days before the beginning of the performance period for which significant risk-takers are being identified. A covered person who is above the one-third threshold would be a significant risk-taker under the proposed rule if he or she meets either (i) the relative compensation test or (ii) the exposure test.
Relative Compensation Test: The relative compensation test would require a covered institution to determine which covered persons received the highest annual base salary and incentive-based compensation among all individuals receiving incentive-based compensation from the covered institution and any affiliates. A covered person would be a significant risk-taker if the person receives annual base salary and incentive-based compensation for the last calendar year that ended at least 180 days before the beginning of performance period that places the person among the highest (i) 5% of all covered persons for a Level 1 covered institution or (ii) 2% for a Level 2 covered institution in salary and incentive-based compensation (excluding senior executive officers) of the covered institution and any affiliates of the covered institution. The calculation would not include fringe benefits such as the value of medical insurance or the use of a company car.
Exposure test: Under the exposure test, a covered person would be a significant risk-taker with regard to a covered institution if the individual may commit or expose 0.5% or more of capital of the covered institution (or any affiliates of the covered institution regardless of whether the individual is employed by that affiliate) to risk of loss due to market risk or credit risk. The exposure test does not relate to the ability of a covered person to expose a covered institution to other types of risk, such as compliance risk.
The exposure test would be measured on an annual basis. The measure of capital would relate to a covered person’s authority over the course of the most recent calendar year, in the aggregate, and would be based on the maximum amount that the person has authority to commit or expose during the year. For example, a Level 2 covered institution might allocate $10 million to a particular covered person as an authorized level of lending for a calendar year, in which case the covered person’s authority to commit or expose would be $10 million. The exposure test would also include each individual who is a voting member of a committee that has the decision-making authority to commit or expose 0.5% or more of the capital of a covered institution (or an affiliate).
Finally, the proposed rule would allow covered institutions or the Agencies the flexibility to designate additional persons as significant risk-takers. Each Agency would use its own procedures for making such a designation. Such procedures generally would include reasonable advance written notice of the proposed action, including a description of the basis for the proposed action, and opportunity for the covered person and covered institution to respond.
Covered person: The proposed rule defines “covered person” as any senior executive officer, significant risk-taker, executive officer, employee, director, or principal shareholder who receives incentive-based compensation at a covered institution, with the most significant limitations and prohibitions applicable to senior executive officers and significant risk-takers.
Senior Executive Officer: The proposed rule defines “senior executive officer” as a covered person who holds the title or, without regard to title, salary, or compensation, performs the function of one or more of the following positions at a covered institution for any period of time in the relevant performance period:
- chief executive officer,
- executive chairman,
- chief operating officer,
- chief financial officer,
- chief investment officer,
- chief legal officer,
- chief lending officer,
- chief risk officer,
- chief compliance officer,
- chief audit executive,
- chief credit officer,
- chief accounting officer, or
- head of a major business line or control function.
Readers probably thought I was exaggerating in last Friday’s post when I said, “If you are a lawyer, compensation committee member, or other executive compensation professional, you may need to learn a new language, as the proposed rules create a series of new definitions – many of which do not match with professionals’ common understanding of the meaning of those terms.”
Again, I want to remind readers who do not work for a financial institution not to ignore this rule (and my posts). Rather, view them as a preview of SEC requirements and/or “best practices” coming soon to a company or board meeting near you.