As the clock ticks toward the July 22 comment deadline for the proposed Dodd-Frank incentive compensation rules, entities that may be covered by the rules continue to evaluate the potential effects on their operations and their compensation practices. The rules could significantly affect how financial institutions provide incentive-based compensation to their employees. As proposed, the rules would impose obligations such as lengthy clawback periods; deferral of compensation; limitations on “excessive” compensation; specific governance requirements; and long recordkeeping periods.
For insurance companies, a more basic question still remains to be clarified—whether they will be covered by the rules at all and, if so, how.
It appears from a close read that the rule, as proposed, would cover (at minimum) certain insurance providers, such as those that are subsidiaries of a bank holding company (BHC). This would mean that those particular insurance companies would have to implement the governance requirements and reasonableness metrics mandated by the rule for all covered entities, as well as, potentially, the extensive and prescriptive requirements applicable to entities of larger asset sizes, such as clawbacks and deferrals.
Potentially affected companies should carefully review the proposal and consider submitting comments before the public comment period closes on July 22, 2016. It is important to keep in mind that many aspects of the proposed rule could change in the rulemaking process, including how and whether other insurance companies will be covered. Such changes could be made in response to comments, all of which the agencies will read and consider.
Section 956 of the Dodd-Frank Act requires the issuance of “regulations or guidelines” prohibiting incentive-based payment arrangements encouraging inappropriate risk-taking by “covered financial institutions” with $1 billion or more in assets. Such regulations or guidelines are to be issued by the Federal Reserve, Office of the Comptroller of the Currency (OCC), FDIC, National Credit Union Administration (NCUA), Securities and Exchange Commission (SEC), and Federal Housing Finance Agency (FHFA).
The proposed rule imposes certain requirements on all covered entities, and imposes additional requirements on two categories of larger entities—those with $50 billion and $250 billion in assets, respectively. As proposed, the rule measures asset size on a consolidated basis, so that even a small insurance company or other entity could be swept into the much more onerous requirements applicable to larger entities, if that insurance company is part of a holding company family of sufficient size to trip those larger size thresholds. The proposed rule also gives regulators some discretion to apply the requirements applicable to larger entities to smaller ones. Thus, even smaller entities should be sure to review the proposed requirements that would apply to larger ones.
It is unclear when a final rule will eventually be issued. The proposed compliance date would be no later than the beginning of the first calendar quarter that begins at least 540 days (about a year-and-a-half) after a final rule is published in the Federal Register. The final rule would not apply to any incentive compensation plan with a performance period that begins before the compliance date.
Key Issues: Insurance Companies as “Covered Financial Institutions”
Section 956 defines “covered financial institution” to explicitly include entities such as depository institutions, depository institution holding companies, credit unions, SEC-registered broker-dealers, and investment advisers. The statute also provides that the definition shall also include “any other financial institutions that the appropriate Federal regulators”—those listed above—“jointly, by rule, determine should be treated as a covered financial institution for purposes of this section.” It does not explicitly state what limits apply to the agencies’ ability to bring additional entities—such as nonfinancial companies—within the rule as “covered financial institutions.”
Each participating agency has drafted its version of the proposed rule to generally cover the types of entities that the agency supervises. But the OCC and FDIC specifically have carved out any “person providing insurance” from their definition of who is covered. By contrast, the Fed’s version of this language does not include that carveout language—it does not mention “person providing insurance” at all. Instead, it provides that its rule would cover a subsidiary of a BHC “that is not a depository institution, broker-dealer or investment adviser.” This implies that an insurance subsidiary of a BHC could be covered.
The SEC’s version of the rule does not explicitly state that insurance companies are included or excluded; it limits its coverage to broker-dealers and investment advisers, but some insurance providers could fall under those categories. In addition, in soliciting comments on the proposal, the agencies specifically ask a question related to insurance companies that are investment advisers: “Should the determination of average total consolidated assets be further tailored for certain types of investment advisers, such as charitable advisers, non-U.S.-domiciled advisers, or insurance companies (emphasis added) and, if so, why and in what manner?” Thus, it seems that the SEC means for its rule to capture insurance companies, at least to some extent.
Even if the rules do apply to insurance companies, another important question remains: who would enforce the rule against such companies? Despite its supervisory authority over subsidiaries of BHCs generally, the Fed has only limited supervision and enforcement authority regarding insurance subsidiaries of BHCs. Instead, such authority primarily resides with state insurance authorities.
All these issues are ripe for comment and consideration by the agencies as part of the rulemaking process. Insurance companies and others that may be impacted by this regulation should consider submitting comments to request clarification or specific changes, or to request that proposed language should be finalized as proposed, since the agencies will read, log, and consider all comments they receive.