The FDIC is considering changes to its risk-based deposit insurance assessment system to account for risks posed by certain employee compensation programs. The FDIC issued an advance notice of proposed rulemaking on January 14 to seek comments about whether and how to incorporate employee compensation criteria into the risk-based assessment system. The FDIC said that some types of compensation programs can increase losses to the Deposit Insurance Fund (DIF) because they provide incentives for bank employees to engage in excessive risk taking which can ultimately increase a bank’s risk of failure. The FDIC examined Material Loss Reviews conducted in 2009 that addressed the factors contributing to losses resulting from 49 bank failures and found that employee compensation practices were a contributing factor in 35% of those cases. The FDIC is requesting comments to identify criteria for adjustments to the risk-based assessment system in order to correctly price and assess the risks presented by certain compensation programs to adequately compensate the DIF for the risks inherent such programs. Comments must be submitted to the FDIC on or before February 18.

Nutter Notes: The employee compensation criteria would focus on whether an employee compensation program is likely to align employee performance with the long-term interests of the bank and its stakeholders, including the FDIC. The notice suggests certain features of compensation programs that may help to discourage excessive risk-taking and meet the FDIC’s goals. For employees (including senior management) of stock institutions whose business activities can present greater risk to the bank and who also receive a portion of their compensation according to formulas based on the achievement of performance goals, the FDIC suggests that, in lieu of cash or immediately exercisable stock options, a significant portion of such employees’ compensation should be comprised of restricted, non-discounted company stock awards that vest at intervals over a period of years. The FDIC also suggests that the stock initially be awarded at the closing price in effect on the day of the award. Significant awards of stock should become vested over a multi-year period and should be subject to a claw-back designed to account for the outcome of risks assumed in earlier periods. Finally, the FDIC suggests that compensation programs should be administered by a committee of independent directors, with input from independent compensation professionals. The FDIC is considering whether banks that are able to attest that their compensation programs include those features present a lower risk to the DIF and, as a result, should face a lower risk-based assessment rate than those banks that cannot make that kind of an attestation.