whereas boards of directors responded by moderating risk-taking
incentives in situations where these incentives were particularly
strong, such an effect was absent at the very largest banks with strong
growth opportunities.
---------------------------------------------------------------------------

    \352\ See Bebchuk, L., Cohen, A., Spamann, H. 2010. The Wages of
Failure: Executive Compensation at Bear Stearns and Lehman 2000-
2008. Yale Journal on Regulation 27, 257-282. The study presents
details regarding payouts made to CEOs and executives of Bear Sterns
and Lehman Brothers during the 2000-2008 period. During the 2000-
2008 period, executive teams at Bear Sterns cashed out a total of
$1.4 billion in cash bonuses and equity sales whereas the executives
at Lehman cashed out a total of $1 billion. The authors argue that
the divergence between how top executives and their shareholders
fared may suggest that pay arrangements provided incentives for
excessive risk taking.
    See Bhagat, S., Bolton, B. 2013. Bank Executive Compensation and
Capital Requirements Reform. Working Paper. The study examines,
among other things, 2000-2008 net payoffs to CEOs of 14 financial
institutions that received TARP assistance during the crisis.
Consistent with the findings of Bebchuk et al. (2010), this study
shows that CEOs of TARP assisted institutions cashed out significant
amounts of compensation prior to the crisis, but also suffered
significant losses when the crisis hit. The authors find that TARP
CEOs cashed out significantly higher amounts of compensation during
the 2000-2008 period compared to other institutions that did not
receive TARP assistance; the finding is interpreted as evidence that
TARP CEOs were aware of the increased risks associated with their
actions and significantly limited their exposure to firm performance
before the crisis hit.
    \353\ See DeYoung, R., Peng, E., Yan, Meng. 2013. Executive
Compensation and Business Policy Choices at U.S. Commercial Banks.
Journal of Financial and Quantitative Analysis 48, 165-196. The
study examines CEOs' risk-taking incentives at large commercial
banks over the 1995-2006 period. The authors link the increase in
risk-taking incentives at these banks to growth opportunities due to
deregulation. They find that board of directors moderated CEO risk-
taking incentives but this effect is absent at the largest banks
with strong growth opportunities and a history of highly aggressive
risk-taking incentives.
---------------------------------------------------------------------------

    Finally, there are also studies that argue that compensation
structures were not responsible for the differential risk-taking and
performance of financial institutions during crises. In particular, a
study argues that the differential risk culture across banks determines
the differential performance of these institutions.\354\ For example,
banks that performed poorly during the 1998 crisis were also found to
perform poorly, and had higher failure rates, during the recent
financial crisis. Another recent study argues that, prior to 2008,
risk-taking was inherently different across financial institutions and
the fact that high-risk financial institutions paid high amounts of
compensation to their executives was not an indicator of excessive
compensation practices but represented compensation for the additional
risk to which executives' wealth was exposed.\355\ The study

suggests that at financial institutions, compensation was the result of
efficient contracting between managers and shareholders. The study did
not find support for the view that compensation determined risk-taking
and ultimately led to the failure of many institutions.
---------------------------------------------------------------------------

    \354\ See Fahlenbrach, R., Prilmeier, R., Stulz, R. 2012. This
Time Is the Same: Using Bank Performance in 1998 to Explain Bank
Performance during the Recent Financial Crisis. Journal of Finance
67, 2139-2185. The paper examines whether inherent business models
or/and culture drive certain banks to perform worse during crises.
The study documents that banks that performed poorly, performance
measured in terms of stock returns, after Russia's default in 1998
were also likely to perform poorly during the recent financial
crisis. These banks had greater degrees of leverage, relied more on
short-term market funding and grew faster during the years leading
up to both crisis periods. The authors interpret their findings as
being attributable to differential risk-taking cultures across banks
that persist over time.
    \355\ See Cheng, I., Hong, H., Scheinkman, J. 2015. Yesterday's
Heroes: Compensation and Risk at Financial Firms. Journal of Finance
70, 839-879. The paper examines the link between managerial pay and
risk taking in the financial industry. Specifically, the paper
builds upon efficient contracting theory to predict that managers in
companies facing greater amounts of uncontrollable risk would
require higher levels of compensation. Given that higher levels of
uncontrollable risk expose managerial compensation to increased
risk, risk averse managers require additional compensation for the
increased risk exposure. Using various measures of arguably
uncontrollable company risk, such as lagged risk measures and risk
measures when the company had an IPO, the authors find a positive
relation between current compensation and historical measures of
risk. They interpret their results as inherent differences in risk
among financial companies driving differences in compensation levels
among these companies.
---------------------------------------------------------------------------

    Taken all together, while there is debate about certain amounts,
components, and features of incentive-based compensation that
potentially encourage risk-taking, the existing academic literature
does not provide conclusive evidence about a specific type of
incentive-based compensation arrangement that leads to inappropriate
risk-taking without taking into account other considerations, such as
firm characteristics or other governance mechanisms. In particular,
there may be mitigating factors--some more effective than others--that
allow efficient contracting to develop compensation arrangements for
managers to align managerial interests with shareholders' interests and
provide incentives for maximization of shareholder value.
    If it is the case that some institutions are able to contract
efficiently for compensation arrangements, for any such institution
that is a covered BD or IA with large balance sheet assets, and if such
institution does not pose potentially negative externalities on
taxpayers, the proposed rule may curtail the pay convexity resulting
from such efficient contracting between managers and shareholders with
potential unintended consequences. In particular, unintended
consequences may include curbing risk-taking incentives to a level that
is lower than what shareholders deem optimal, with consequent negative
effects on efficiency and shareholder value. These potential negative
effects on efficiency and shareholder value could manifest themselves
in a number of ways. For example, the lower-than-optimal level of risk-
taking could affect covered BDs' and IAs' transactions for their own
accounts as well as operations that involve customers and clients. The
SEC expects that whether such consequences occur would depend on the
specific facts and circumstances of each covered BD or IA.
    In addition, the proposed rule may result in losses of managerial
talent that may migrate from covered institutions to firms in different
industries or abroad, especially if CEOs have developed, in recent
decades, general managerial skills that are transferable across firms
and industries, as some studies assert.\356\ It should be noted,
however, as the discussion in the Preamble suggests, that some foreign
regulators (e.g., in UK) have adopted stricter limits on incentive-
based compensation. Thus, some foreign regulators' restrictions on
incentive-based compensation may limit the likelihood of human capital
migrating to foreign institutions subject to those restrictions.
Moreover, given that incentive-based compensation is also designed to
attract and retain managerial talent, the proposed rule may result in
an increased level of total compensation to make up for the limits
imposed to award opportunities, for the decrease in present value of
the awards that are deferred, or for the increase in the uncertainty
associated with the fact that managers may not be able to retain the
compensation awards due to the potential for forfeiture during the
deferral period and/or clawback during the period following vesting of
such awards. If these unintended consequences occur, they may
contribute to reduce the competitiveness of certain U.S. financial
institutions in their role of intermediation, potentially affecting
other industries.
---------------------------------------------------------------------------

    \356\ See Custodio, Claudia, Miguel Ferreira, and Pedro Matos.
2013. Generalists versus Specialists: Lifetime Work Experience and
Chief Executive Officer Pay. Journal of Financial Economics 108,
471-492.
---------------------------------------------------------------------------

    On the other hand, for those covered institutions, including BDs
and IAs with large balance sheets, that do have the potential to
generate negative externalities, the proposed rule may result in better
alignment of incentives between managers at these institutions and
taxpayers and hence may have potential benefits by lowering the
likelihood of an outcome that may induce negative externalities.
Lowering the likelihood of negative externalities would be beneficial
for the long-term health of these institutions, other institutions that
are interconnected with those covered institutions and, in turn, the
long-term health of the U.S. economy. The extent of these potential
benefits, as mentioned above, would depend on specific facts and
circumstances at the firm level and individual level.
C. Baseline
    The baseline for the SEC's economic analysis of the proposed rule
includes the current incentive-based compensation practices of those
covered institutions that are regulated by the SEC--registered broker-
dealers and investment advisers--and the relevant regulatory
requirements that may currently affect such compensation
practices.\357\
---------------------------------------------------------------------------

    \357\ When referencing investment advisers, the SEC's economic
analysis references those institutions that meet the definition of
investment adviser under section 202(a)(11) of the Investment
Advisers Act, including any such institutions that may be prohibited
or exempted from registering with the SEC under the Investment
Advisers Act and any that are exempt from registration but are
reporting.
---------------------------------------------------------------------------

1. Covered Institutions
    Section 956(f) limits the scope of the requirements to covered
institutions with total assets of at least $1 billion. The proposed
rule defines covered institution as a regulated institution that has
average total consolidated assets of $1 billion or more. Regulated
institutions include covered BDs and IAs. Based on their average total
consolidated assets, the proposed rule further classifies covered
institutions into three levels: Level 1 covered institutions with
average total consolidated assets greater than or equal to $250
billion; Level 2 covered institutions with average total consolidated
assets greater than or equal to $50 billion, but less than $250
billion; and Level 3 covered institutions with average total
consolidated assets greater than or equal to $1 billion, but less than
$50 billion.
    In the case of BDs and IAs, a Level 1 BD or IA is a covered
institution with average total consolidated assets greater than or
equal to $250 billion, or a covered institution that is a subsidiary of
a depository institution holding company that is a Level 1 covered
institution. A Level 2 BD or IA is a covered institution with average
total consolidated assets greater than or equal to $50 billion that is
not a Level 1 covered institution; or a covered institution that is a
subsidiary of a depository institution holding company that is a Level
2 covered institution. A Level 3 BD or IA is a covered institution with
average total consolidated assets greater than or equal to $1 billion
that is not a Level 1 covered institution or Level 2 covered
institution
    Table 1 shows the number of covered BDs and IAs as of December 31,
2014, sorted by the size of a BD or IA as a covered institution by
itself, without considering the size of that covered institution's
parent depository holding company, if any (hereafter, ``unconsolidated
Level 1,'' ``unconsolidated Level 2,'' and ``unconsolidated Level 3''
BDs and

IAs).\358\ We use 2014 data in our analysis because this is the most
recent year for which compensation data is available. From FOCUS
reports, there were 131 BDs with total assets above $1 billion at the
end of calendar year 2014.\359\ From Item 1(O) of Form ADV the SEC
estimated that, out of 11,702 IAs registered with the SEC, or reporting
to the SEC as an exempt reporting adviser, 669 IAs had total assets of
at least $1 billion as of December 31, 2014, although the SEC lacks
information that allows it to further classify these IAs as Level 1,
Level 2, or Level 3 covered institutions.\360\
---------------------------------------------------------------------------

    \358\ The terms ``unconsolidated Level 1 covered institution,''
``unconsolidated Level 2 covered institution,'' and ``unconsolidated
Level 3 covered institution'' used in the SEC's economic analysis
differ from the terms ``Level 1 covered institution,'' ``Level 2
covered institution,'' and ``Level 3 covered institution'' as
defined in the proposed rule.
    \359\ Total assets are taken from FOCUS report, Part II
Statement of Financial Condition. The assets reported in the FOCUS
report are required to be consolidated total assets if a BD has
subsidiaries.
    \360\ Form ADV requires IAs to report consolidated balance sheet
assets. The 669 number includes 59 IAs that are not registered with
the SEC but are reporting.

                            Table 1--Number of Broker-Dealers and Investment Advisers
----------------------------------------------------------------------------------------------------------------
                                           Unconsolidated    Unconsolidated    Unconsolidated
               Institution                     Level 1           Level 2           Level 3            Total
----------------------------------------------------------------------------------------------------------------
Broker-dealers (BDs)....................                 7                13               111               131
Investment advisers (IAs)...............               n/a               n/a               n/a               669
----------------------------------------------------------------------------------------------------------------

i. Broker-Dealers
    In 2014, 4,416 unique BDs filed FOCUS reports. Of these 4,416 BDs,
seven had total assets greater than $250 billion (Level 1 BDs), 13 had
total assets between $50 billion and $250 billion (unconsolidated Level
2 BDs), and 111 had total assets between $1 billion and $50 billion
(unconsolidated Level 3 BDs) in 2014.\361\ As shown in Table 2, these
unconsolidated Level 3 BDs had total assets equal to $9.6 billion on
average and $3.7 billion in median; and about 70 percent (78 out of
111) of them had total assets below $10 billion.
---------------------------------------------------------------------------

    \361\ For purposes of this analysis, the SEC determined the
unconsolidated level of each BD. For example, if a BD alone had
total assets between $1 billion and $50 billion at the end of at
least one calendar quarter in 2014, it was classified in this
economic analysis as an unconsolidated Level 3 BD. Similarly, if a
BD alone had total assets between $50 and $250 billion (greater than
$250 billion) in at least one quarter in 2014, it was classified in
this economic analysis as an unconsolidated Level 2 (Level 1) BD.
This classification method differs from the proposed rule. Thus,
some of the unconsolidated Level 2 and unconsolidated Level 3 BDs
discussed in this economic analysis may be Level 1 and Level 2
covered institutions after consolidation and for purposes of the
proposed rule. Given that an unconsolidated Level 1 BD alone has
greater than or equal to $250 billion in total assets, an
unconsolidated Level 1 BD would be a Level 1 covered institution for
purposes of the proposed rule, regardless of consolidation.

                                        Table 2--Size Distribution of BDs
----------------------------------------------------------------------------------------------------------------
                                                   Mean size ($   Median size ($   Size range ($   Number of BDs
             BD size               Number of BDs     billion)        billion)        billion)     per size range
----------------------------------------------------------------------------------------------------------------
Below $1 billion................           4,285           $0.02          $0.001
$1-$49 billion (Unconsolidated               111             9.6             3.7            <=10              78
 Level 3).......................
                                                                                10-20              16
                                  ..............  ..............  ..............           20-30               3
                                  ..............  ..............  ..............           30-40              12
                                  ..............  ..............  ..............             >40               2
$50-$250 billion (Unconsolidated              13            90.6            80.3          50-100               9
 Level 2).......................
                                  ..............  ..............  ..............        100-$150               2
                                  ..............  ..............  ..............         150-200               2
                                  ..............  ..............  ..............            >200               0
Over $250 billion (Level 1).....               7           312.3           275.2         250-300               4
                                  ..............  ..............  ..............         300-350               2
                                  ..............  ..............  ..............         350-400               0
                                  ..............  ..............  ..............            >400               1
----------------------------------------------------------------------------------------------------------------

    The SEC's analysis indicates that, in 2014, all of the
unconsolidated Level 1 and unconsolidated Level 2 BDs were subsidiaries
of a holding company or parent institution. Of these parent
institutions, only one was not a depository institution holding
company. The majority of the unconsolidated Level 3 BDs were also part
of a larger corporate structure. It should be noted that some parent
institutions owned more than one BD. Out of the 111 unconsolidated
Level 3 BDs, 21 BDs were non-reporting, stand-alone institutions (i.e.,
entities that are not part of a larger corporate structure).
    In Table 3, the parent institutions of the affected BDs are
classified into Level 1, Level 2, or Level 3, based on the ultimate
parent's total consolidated assets.\362\ As of the end of 2014, there
were 23 unique Level 1 parents and 9 unique Level 2 parents that owned
covered Level 1, unconsolidated Level 2, and unconsolidated Level 3
BDs. An additional 18 unique parents were Level 3 covered institutions,
and those owned only unconsolidated Level 3 BDs. The SEC was not able
to classify 29 parent institutions due to the lack of data on their
total consolidated assets.
---------------------------------------------------------------------------

    \362\ The name of the ultimate parent was obtained using the
company information in the Capital IQ database. The SEC found total
assets information for public parents in the Compustat database.
Total assets information for some of the private parents the SEC
found in the Capital IQ database.

                            Table 3--Distribution of BDs by Level Size of the Parent
----------------------------------------------------------------------------------------------------------------
                                                      BD as a subsidiary of a
                                 ---------------------------------------------------------------- BD as a stand-
                                                                                Parent size n/       alone
                                  Level 1 parent  Level 2 parent  Level 3 parent         a          institution
----------------------------------------------------------------------------------------------------------------
Number of unconsolidated Level 1               7               0               0               0               0
 BDs............................
Number of unique parents........               7  ..............  ..............  ..............  ..............
Number of public parents........               7  ..............  ..............  ..............  ..............
Median BD assets ($ billion)....          $275.2  ..............  ..............  ..............  ..............
Median parent assets ($ billion)        $1,882.9  ..............  ..............  ..............  ..............
Number of unconsolidated Level 2              13               0               0               0               0
 BDs............................
Number of unique parents........              11  ..............  ..............  ..............  ..............
Number of public parents........              11  ..............  ..............  ..............  ..............
Median BD assets ($ billion)....           $80.3  ..............  ..............  ..............  ..............
Median parent assets ($ billion)        $1,702.1  ..............  ..............  ..............  ..............
Number of unconsolidated Level 3              18              11              23              36              23
 BDs............................
Number of unique parents........              14               9              19              29  ..............
Number of public parents........              14               8              17  ..............  ..............
Median BD assets ($ billion)....            $9.5            $4.0            $3.0            $4.4  ..............
Median parent assets ($ billion)          $850.8          $127.7            $9.2             n/a  ..............
                                 -------------------------------------------------------------------------------
    Total number of unique                    23               9              19              29  ..............
     parents....................
                                 -------------------------------------------------------------------------------
    Total number of public                    23               8              17  ..............  ..............
     parents....................
----------------------------------------------------------------------------------------------------------------

    The majority of BDs that were subsidiaries were held by a parent
registered with the SEC as a reporting institution (i.e., public
company). All parents of Level 1 BDs and almost all of the parents of
unconsolidated Level 2 BDs were public companies, while 39 out of the
71 unique parents of unconsolidated Level 3 BDs were public companies.
Twenty three BDs were not subsidiaries but stand-alone companies that
were private Level 3 BDs.
ii. Investment Advisers
    The SEC does not have a precise way of distinguishing among the
largest IAs because Form ADV requires an adviser to indicate only
whether it has $1 billion or more in assets on the last day of its most
recent fiscal year.\363\ In addition, the information contained on Form
ADV relates only to registered investment advisers and exempt reporting
advisers, while the proposed rule would apply to all investment
advisers.\364\ As of December 2014, there were 669 IAs with assets of
at least $1 billion, of which 129 IAs were affiliated with banking or
thrift institutions.\365\ For the remaining 540 IAs the SEC does not
have information on how many of them are stand-alone companies and how
many are affiliated with non-bank parent companies. Of the 669 IAs, 51
are dually registered as BDs with the SEC.\366\ Of the 129 IAs
affiliated with banking or thrift institutions, 39 IAs are affiliated
with banks and thrifts with $50 billion or more in assets. Of the 39
IAs, 10 IAs were affiliated with banks and thrift institutions with
assets between $50 billion and $250 billion; and 23 IAs were affiliated
with banks and thrift institutions with assets of more than $250
billion. As Table 4 shows, the 39 IAs have 25 unique parent
institutions and most of these parent institutions (17) are public
companies.
---------------------------------------------------------------------------

    \363\ See Item 1.O of Part 1A of Form ADV. As noted above, the
SEC has not historically examined its regulated entities' use of
incentive-based employee compensation. In this regard, Form ADV does
not contain information with respect to such practices.
    \364\ By its terms, the definition of ``covered financial
institution'' in section 956 includes any institution that meets the
definition of ``investment adviser'' under the Investment Advisers
Act, regardless of whether the institution is registered as an
investment adviser under that Act. Most investment advisers
(including registered investment advisers, exempt reporting
advisers, or otherwise) currently do not report to the SEC their
average total consolidated assets, so the SEC is unable to determine
with particularity how many have average total consolidated assets
greater than or equal to $1 billion and less than $50 billion,
greater than or equal to $50 billion and less than $250 billion, or
greater than or equal to $250 billion. The estimates used in this
section with respect to investment advisers, however, are based on
data reported by registered investment advisers and exempt reporting
advisers with the SEC on Form ADV, because the SEC estimates that it
is unlikely that investment advisers that are prohibited from
registering with the SEC would be subject to the proposed rule.
    \365\ Form ADV requires an adviser to indicate whether it has a
``related person'' that is a ``banking or thrift institution,'' but
does not require an adviser to identify a related person by type
(e.g., a depository institution holding company). See Item 7 of Part
1A and Item 7.A of Schedule D to Form ADV. These estimates are
therefore limited by the information reported by registered
investment advisers and exempt reporting advisers in their Forms ADV
and has necessitated manual referencing of the institutions
specified.
    \366\ Because the data presented below for the effects on BDs
and IAs are presented separately, in aggregate, they may overstate
the costs and other economic effects for dual registrants.

   Table 4--Distribution of 39 IAs Affiliated With Level 1 and Level 2 Banks and Thrifts, by Level Size of the
                                                     Parent
----------------------------------------------------------------------------------------------------------------
                                                                              IA as a subsidiary of a
                                                                 -----------------------------------------------
                                                                                Parent size n/
                                                                  Level 1 parent  Level 2 parent         a
----------------------------------------------------------------------------------------------------------------
Number of IAs...................................................              23              10               6
Number of unique parents........................................              10               9               6
Number of public parents........................................              10               7               0
----------------------------------------------------------------------------------------------------------------

2. Current Incentive-Based Compensation Practices
    The SEC does not have information on the incentive-based
compensation practices of the BDs and IAs themselves. The main reason
why the SEC lacks such information is that BDs and IAs are generally
not public reporting companies and as a result they do not provide the
type of compensation information that a public reporting company would
file with the SEC as part of its communications with shareholders.
Notwithstanding these limitations on the data regarding the incentive-
based compensation arrangements at BDs or IAs, when the BDs or IAs are
subsidiaries of public reporting companies, the SEC has information for
the public reporting company that is the parent of these BDs and IAs.
In particular, the information on incentive-based compensation
practices for named executive officers (``NEOs'') is annually disclosed
in proxy statements and annual reports filed with the SEC. NEOs
typically include the principal executive officer, the principal
financial officer, and three most highly compensated executives.\367\
---------------------------------------------------------------------------

    \367\ For a company that is not a smaller reporting company,
Item 402(a)(3) of Regulation S-K defines named executive officers
as: (1) All individuals serving as the company's principal executive
officer or acting in a similar capacity during the last completed
fiscal year (PEO), regardless of compensation level; (2) All
individuals serving as the company's principal financial officer or
acting in a similar capacity during the last completed fiscal year
(PFO), regardless of compensation level; (3) The company's three
most highly compensated executive officers other than the PEO and
PFO who were serving as executive officers at the end of the last
completed fiscal year; and (4) Up to two additional individuals for
whom disclosure would have been provided under the immediately
preceding bullet point, except that the individual was not serving
as an executive officer of the company at the end of the last
completed fiscal year.
---------------------------------------------------------------------------

    Given that it lacks data on the BDs and IAs themselves, for the
purposes of this economic analysis, the SEC uses data on incentive-
based compensation of the NEOs at the parent institutions, which for
unconsolidated Level 1 and unconsolidated Level 2 BDs are mostly bank
holding companies,\368\ as an indirect measure of incentive-based
compensation practices at the subsidiary level.\369\ The SEC also
analyzes the incentive-based compensation of public reporting
institutions with assets between $1 billion and $50 billion, many of
which are not bank holding companies, because it is possible that size
may be a determinant of incentive-based compensation arrangements and
thus the incentive-based compensation of an unconsolidated Level 3 BD
or IA may be more similar to that of a public reporting institution
with assets between $1 billion and $50 billion.
---------------------------------------------------------------------------

    \368\ For Level 1 and unconsolidated Level 2 BDs, the SEC's
analysis indicates that, as of December 2014, two of their 20 unique
parent institutions are non-bank holding companies (one investment
management firm and one investment bank/brokerage). For the 39 IAs
described in Table 4, six of their 25 unique parent institutions are
not bank holding companies, For unconsolidated Level 3 BDs, 20 of
the 42 unique parent institutions for which data on their size is
available are not bank holding companies.
    \369\ It is also possible that the compensation practices
between Level 1 parent and unconsolidated Level 2 subsidiary (or
between Level 2 parent and unconsolidated Level 3 subsidiary) may be
closer to each other than those of Level 1 parent and unconsolidated
Level 3 subsidiary.
---------------------------------------------------------------------------

    While the SEC utilizes the above-referenced public reporting
company data, it should be noted that there are a number of caveats
that may impact the SEC's analysis. First, the incentive-based
compensation arrangement at the subsidiary level may differ from that
of the parent level due to either the difference between the size of
the subsidiary relative to the size of the parent, or because the
business model of the subsidiary is different from that of the parent.
More specifically, the incentive-based compensation arrangement of bank
holding companies may be different than that of BDs or IAs given the
fundamentally differing natures of the underlying business models and
the composition of their respective balance sheets. Further, the
incentive-based compensation practices at a public reporting company
could be different than those at a non-public reporting company. The
SEC also does not have information about incentive-based compensation
of non-NEOs and of those employees included in the definition of
significant risk-takers under the proposed rule. These caveats mean
that the SEC's analysis, which is mainly based on data from public bank
holding companies, may not accurately reflect incentive-based
compensation practices at BDs and IAs. To address this lack of data,
the SEC has supplemented its analysis with anonymized supervisory data
from the Board and the OCC, with limitations to the generalizability of
the analysis on non-NEOs and significant risk-takers similar to the
ones discussed above.
i. Named Executive Officers
    Table 5A presents data on the compensation structure of NEOs at
Level 1, Level 2, and Level 3 parent public reporting institutions of
unconsolidated Level 1, unconsolidated Level 2, and unconsolidated
Level 3 BDs as of the end of fiscal year 2014.\370\ In addition to the
CEO and the CFO, NEOs typically include the chief operating officer
(``COO''), the general counsel (``GC''), and the heads of business
units such as wealth management and investment banking. As shown in
Table 5A, incentive-based compensation is a significant component of
NEO compensation at parent institutions. It is approximately 90 percent
of total compensation for Level 1 parent institutions and 85 percent
for Level 2 parent institutions (median values are also reported in
parentheses).\371\ Additionally, a sizable fraction of incentive-based
compensation is in the form of long-term incentive compensation, which
is mainly awarded in the form of stock, stock options, or debt
instruments.\372\ The SEC observes that the use of stock options varies
by size of the parent institution: Stock options represent on average 6
percent of long-term incentive compensation for Level 1 parents, while
they represent approximately 20 percent of long-term incentive
compensation for Level 2 parents.\373\
---------------------------------------------------------------------------

    \370\ Data comes from Compustat's ExecuComp database. Out of 30
unique Level 1 and Level 2 parent institutions of Level 1, Level 2,
and Level 3 BDs, compensation data is not available for 16 parent
institutions.
    \371\ Incentive-based compensation is determined as Total
compensation as reported in SEC filings--Salary.
    \372\ Long-term incentive compensation is determined using the
following items from Compustat's ExecuComp database: Total
compensation as reported in SEC filings--Salary--Bonus--Other annual
compensation. Short-term incentive compensation is determined as
Bonus + Other annual compensation.
    \373\ This is consistent with evidence of decreased use of stock
options in compensation arrangements over the last decade, with
companies replacing the use of stock options with restricted stock
units. See Frydman and Jenter, CEO Compensation, Annual Review of
Financial Economics (2010).

                    Table 5A--Compensation Structure of BD Parent Institutions by Level Size
----------------------------------------------------------------------------------------------------------------
                                                                  Level 1 parent  Level 2 parent  Level 3 parent
----------------------------------------------------------------------------------------------------------------
Incentive-based compensation as percent of total compensation...       90% (90%)       85% (86%)       83% (87%)
Short-term incentive compensation as percent of total                   15% (0%)         1% (0%)        21% (0%)
 compensation...................................................
Long-term incentive compensation as percent of total                   74% (81%)       85% (86%)       62% (77%)
 compensation...................................................
Option awards as percent of long-term incentive compensation....         6% (0%)       20% (18%)         4% (0%)
Stock awards as percent of long-term incentive compensation.....       68% (69%)       40% (37%)       44% (49%)
Number of NEOs per institution..................................         5.5 (5)         5.3 (5)         5.4 (5)
Number of parent institutions with available compensation data..              10               4               7
----------------------------------------------------------------------------------------------------------------

    Table 5B presents similar statistics for the compensation
structures of Level 1 and Level 2 parent institutions of IAs that were
affiliated with banks and thrift institutions with assets of more than
$50 billion.\374\ The summary statistics for the parent companies of
IAs mirrors the statistics for the BDs' parent companies: A significant
portion of NEO compensation is in the form of incentive-based
compensation, most of which is long-term incentive compensation that
comes in the form of stock awards.\375\ Both Level 1 and Level 2 IA
parents exhibit relatively little use of options.
---------------------------------------------------------------------------

    \374\ There is an overlap between the parent institutions of BDs
and IAs: About half of the IAs' parents are also parents of BDs and
included in Table 5A.
    \375\ This is not surprising given that approximately half of
the IAs' parent institutions are also parent institutions of BDs and
included in Table 5A.

    Table 5B--Compensation Structure of Level 1 and Level 2 IA Parent
                              Institutions
------------------------------------------------------------------------
                                          Level 1 parent  Level 2 parent
------------------------------------------------------------------------
Incentive compensation as percent of           90% (90%)       84% (94%)
 total compensation.....................
Short-term incentive compensation as           20% (28%)         2% (0%)
 percent of total compensation..........
Long-term incentive compensation as            70% (65%)       82% (84%)
 percent of total compensation..........
Option awards as percent of long-term            8% (0%)         9% (0%)
 incentive compensation.................
Stock awards as percent of long-term           71% (73%)       51% (55%)
 incentive compensation.................
Number of NEOs per institution..........         5.2 (5)         5.2 (5)
Number of parent institutions with                     8               5
 available compensation data............
------------------------------------------------------------------------

    Table 6A provides summary statistics for types of incentive-based
compensation currently awarded by parent institutions of BDs, their
vesting periods, and the specific measures on which these awards are
based.\376\ All types of parent institutions use cash in their short-
term incentive compensation. Only 12 percent of Level 1 parent
institutions, and none of the Level 2 parent institutions, defer short-
term incentive compensation that is awarded in cash only. A significant
fraction of Level 1 parent institutions awards short-term incentive
compensation in the form of cash and stock.
---------------------------------------------------------------------------

    \376\ Data for tables 6A through 10B is collected from the 2015
and 2007 proxy statements, 10-Ks, and 20-Fs of the Level 1, Level 2,
and Level 3 parent institutions.

            Table 6A--Type and Frequency of Use of Incentive-Based Compensation Awards--Level 1, Level 2, and Level 3 BD Parent Institutions
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                             Short-term incentive compensation                             Long-term incentive compensation
                              --------------------------------------------------------------------------------------------------------------------------
                                  Level 1 parent       Level 2 parent       Level 3 parent      Level 1 parent      Level 2 parent      Level 3 parent
--------------------------------------------------------------------------------------------------------------------------------------------------------
Number of parent institutions  16.................  5..................  13.................  16................  5.................  13.
 with available compensation
 data.
Fraction of total
 compensation:
    CEO......................  25%................  44%................  39%................  52%...............  45%...............  60%.
    Other NEOs...............  27%................  45%................  59%................  50%...............  40%...............  40%.
Award:
    Cash only--percent of      44%................  100%...............  100%...............  6%................  0%................  0%.
     institutions.
        percent that defer     12%................  0%.................  9%.................  6%................  0%................  0%.
         cash.
    Cash & stock--percent of   56%................  0%.................  0%.................  6%................  0%................  9%.
     institutions.
        Avg percent of stock   55%................
         in ST IC.
        Avg deferral for       3 years............
         stock.
    Restricted stock-percent   ...................  ...................  ...................  56%...............  60%...............  100%.
     of institutions.
        Avg percent of LT IC.  ...................  ...................  ...................  36%...............  26%...............  75%.
        Avg vesting period...  ...................  ...................  ...................  3.5 years.........  3.3 years.........  3.4 years.
        Type of vesting:
            percent with pro-  ...................  ...................  ...................  87%...............  100%..............  82%.
             rata.

            percent with       ...................  ...................  ...................  13%...............  0%................  18%.
             cliff.
    Performance stock--        ...................  ...................  ...................  88%...............  80%...............  36%.
     percent of institutions.
        Avg percent of LT IC.  ...................  ...................  ...................  53%...............  42%...............  44%.
        Avg performance        ...................  ...................  ...................  3.7 years.........  3 years...........  2 years.
         period.
            percent with perf  ...................  ...................  ...................  6%................  0%................  100%.
             period <3yrs.
            percent with       ...................  ...................  ...................  14%...............  0%................  0%.
             vesting.
        Avg vesting period...  ...................  ...................  ...................  3.7 years.........
        Type of vesting:
            percent with pro-  ...................  ...................  ...................  100%..............
             rata.
            percent with       ...................  ...................  ...................  0%................
             cliff.
    Options--percent of        0%.................  0%.................  ...................  12%...............  60%...............  18%.
     institutions.
        Avg percent of LT IC.  ...................  ...................  ...................  4%................  20%...............  39%.
        Avg vesting period...  ...................  ...................  ...................  3.5 years.........  3.3 years.........  3 years.
    Notional bonds--percent    0%.................  0%.................  ...................  6%................  0%................  0%.
     of institutions.
        Avg percent of LT IC.  ...................  ...................  ...................  30%...............
        Avg vesting period...  ...................  ...................  ...................  5 years...........
Performance measures:
    EPS or Net income........  44%................  100%...............  31%................  19%...............  50%...............  38%.
    ROA......................  6%.................  40%................  0%.................  19%...............  25%...............  0%.
    ROE......................  44%................  0%.................  31%................  44%...............  50%...............  31%.
    Pre-tax income...........  25%................  0%.................  62%................  6%................  0%................  54%.
    Capital strength.........  31%................  0%.................  0%.................  6%................  0%................  0%.
    Efficiency ratios........  13%................  40%................  0%.................  6%................  0%................  0%.
    Strategic goals..........  19%................  25%................  23%................  13%...............  0%................  23%.
    TSR......................  19%................  25%................  46%................  56%...............  75%...............  54%.
--------------------------------------------------------------------------------------------------------------------------------------------------------

    A significant percentage of long-term incentive compensation of BD
parent institutions comes in the form of restricted or performance
stock.\377\ Restricted stock accounts for about 36 percent of long-term
incentive compensation at Level 1 parent institutions and approximately
26 percent at Level 2 parent institutions. It has a vesting period of
approximately 3.5 years. Performance stock awards are more popular:
Over 80 percent of Level 1 and Level 2 parent institutions employ
performance stock, which on average accounts for approximately 53
percent of the long-term incentive compensation of Level 1 parents and
42 percent of that of Level 2 parents. Performance stock awards are
frequently evaluated using total shareholder return (``TSR''), return
on equity (``ROE''), return on assets (``ROA''), earnings per share
(``EPS''), or a combination of TSR and one or more accounting measures
of performance over an average of 3.7 years for Level 1 parent
institutions and 3 years for Level 2 parent institutions. About 14
percent of Level 1 parent institutions impose deferral after the
performance period for performance stock. The average deferral period
for these awards is approximately 4 years.
---------------------------------------------------------------------------

    \377\ Restricted stock includes actual shares or share units
that are earned by continued employment, often referred to as time-
based awards. Performance stock consists of stock-denominated actual
shares or share units (performance shares) and grants of cash or
dollar-denominated units (performance units) earned based on
performance against predetermined objectives over a defined period.
---------------------------------------------------------------------------

    Consistent with the results in Table 5A above, stock options do not
appear to be a popular component of incentive-based compensation
arrangements among Level 1 parent institutions. They are more
frequently used by Level 2 parent institutions, for which options
account for approximately 20 percent of long-term incentive
compensation. One of the Level 1 parents also uses debt instruments as
a part of NEOs' long-term incentive compensation, which fully vest
after five years (i.e. cliff vest). Similar results are obtained when
examining the compensation practices of Level 1 and Level 2 parent
institutions of IAs, as the summary statistics in Table 6B suggest.

    Table 6B--Type and Frequency of Use of Incentive-Based Compensation Awards--Level 1 and Level 2 IA Parent
                                                  Institutions
----------------------------------------------------------------------------------------------------------------
                                  Short-term incentive  compensation         Long-term incentive compensation
                              ----------------------------------------------------------------------------------
                                  Level 1 parent       Level 2 parent       Level 1 parent      Level 2 parent
----------------------------------------------------------------------------------------------------------------
Number of parent institutions  10.................  6..................  10.................  6.
 with available compensation
 data.
Fraction of total
 compensation:
    CEO......................  23%................  26%................  64%................  63%.
    Other NEOs...............  27%................  27%................  58%................  59%.

Award:
    Cash only--percent of      60%................  83%................  0%.................  0%.
     institutions.
        percent that defer     10%................  0%.................  0%.................  0%.
         cash.
    Cash & stock--percent of   40%................  17%................  10%................  17%.
     institutions.
        Avg percent of stock   50%................
         in ST IC.
        Avg deferral for       3 years............
         stock.
    Restricted stock--percent  ...................  ...................  80%................  67%.
     of institutions.
        Avg percent of LT IC.  ...................  ...................  51%................  30%.
        Avg vesting period...  ...................  ...................  3.5 years..........  3.8 years.
Type of vesting:
            percent with pro-  ...................  ...................  100%...............  100%.
             rata.
            percent with       ...................  ...................  0%.................  0%.
             cliff.
    Performance stock--        ...................  ...................  80%................  100%.
     percent of institutions.
        Avg percent of LT IC.  ...................  ...................  42%................  56%.
        Avg performance        ...................  ...................  3.9 years..........  2.6 years.
         period.
            percent with perf  ...................  ...................  13%................  0%.
             period <3yrs.
            percent with       ...................  ...................  13%................  0%.
             vesting.
        Avg vesting period...  ...................  ...................  4 years............
Type of vesting:
            percent with pro-  ...................  ...................  100%...............
             rata.
            percent with       ...................  ...................  0%.................
             cliff.
    Options--percent of        0%.................  0%.................  10%................  50%.
     institutions.
        Avg percent of LT IC.  ...................  ...................  25%................  28%.
        Avg vesting period...  ...................  ...................  4 years............  3.2 years.
Performance measures:
    EPS or Net income........  60%................  67%................  20%................  50%.
    ROA......................  10%................  17%................  20%................  17%.
    ROE......................  40%................  33%................  60%................  67%.
    Pre-tax income...........  10%................  0%.................  0%.................  0%.
    Capital strength.........  30%................  0%.................  10%................  17%.
    Efficiency ratios........  30%................  17%................  10%................  17%.
    Strategic goals..........  20%................  17%................  20%................  17%.
    TSR......................  30%................  17%................  50%................  17%.
----------------------------------------------------------------------------------------------------------------

    Table 7A reports whether incentive-based compensation of NEOs at
Level 1, Level 2, and Level 3 parent institutions of BDs is deferred or
subject to clawback, forfeiture, and certain prohibitions.\378\
---------------------------------------------------------------------------

    \378\ From the disclosures provided by reporting companies on
clawback, forfeiture and certain prohibitions, the SEC is able to
establish whether a reporting company currently uses policies that
are in line with the proposed rule, but was not able to establish
compliance with certainty.

   Table 7A--Current Deferral, Clawback, Forfeiture and Certain Prohibitions for NEOs at Level 1, Level 2, and
                                         Level 3 BDs Parent Institutions
----------------------------------------------------------------------------------------------------------------
                                                                  Level 1 parent  Level 2 parent  Level 3 parent
----------------------------------------------------------------------------------------------------------------
Number of parent institutions with available compensation data..              16               5              13
Number of NEOs:
    Total number of NEOs........................................             104              24              66
    Average number of NEOs per institution......................               6               5               5
Deferred compensation:
    Institutions with deferred compensation.....................            100%             80%            100%
Average percent of deferred compensation:
        CEO.....................................................             75%             52%             65%
        Other NEOs..............................................             73%             49%             43%
    Average number of years deferred............................             3.5             2.6             3.3
Type of compensation deferred:
    Institutions with cash......................................             19%             25%              8%
    Institutions with stock.....................................            100%            100%            100%
    Institutions with bonds.....................................              6%             N/A              8%
Clawback and forfeiture:
    Institutions with clawback..................................            100%             80%             92%
    Institutions with forfeiture................................            100%             60%             85%
Prohibitions:
    Institutions prohibiting hedging............................             75%             60%             62%

    Institutions prohibiting volume-driven incentive-based                   N/A             N/A             N/A
     compensation...............................................
    Institutions prohibiting acceleration of payments except in              70%             14%              9%
     case of death and disability...............................
Maximum incentive-based compensation:
    Average percent.............................................            155%            190%            134%
Risk Management:
    Institutions with Risk Committees...........................            100%             67%             62%
    Institutions with fully independent Compensation Committee..             93%             88%             83%
    Institutions where CROs review compensation packages........           31.3%             20%             15%
----------------------------------------------------------------------------------------------------------------

    In general, the SEC's analysis of the compensation information
disclosed in proxy statements and annual reports by parent institutions
of covered BDs suggests that NEO compensation practices at most of the
parent institutions are in line with the main requirements and
prohibitions in the proposed rule. This may not be surprising given
that the baseline already reflects a regulatory response to the
financial crisis.\379\ For example, all Level 1 parents and 80 percent
of Level 2 parents of BDs require some form of deferral of incentive-
based executive compensation. The average Level 1 parent institution
defers 75 percent of incentive-based compensation awarded to CEOs and
73 percent awarded to other NEOs, which is above the minimum deferral
amount that would be required by the proposed rule. In a similar vein,
an average of 52 percent of incentive-based compensation awarded to
CEOs and 49 percent awarded to other NEOs is deferred at Level 2 parent
institutions, similar to what would be required by the proposed rule.
The length of the deferral period at Level 1 and Level 2 parent
institutions is also currently in line with what would be required by
the proposed rule: On average, 3.5 years for NEOs at Level 1 parent
institutions and approximately 3 years for those at Level 2 parent
institutions.
---------------------------------------------------------------------------

    \379\ See, 2010 Federal Banking Agency Guidance, available at:
http://www.federalreserve.gov/newsevents/press/bcreg/20100621a.htm.
---------------------------------------------------------------------------

    Regarding the type of incentive-based compensation that is being
deferred, both Level 1 and Level 2 parent institutions defer equity-
based compensation. One of the Level 1 parent institutions uses debt
instruments as incentive-based compensation and defers it as well. Only
a fraction of them (20 percent of Level 1 and 25 percent of Level 2
parent institutions), however, currently defer incentive-based
compensation in cash; the proposed rule would require deferral of
substantial portions of both cash and equity-like instruments for
senior executive officers and significant risk-takers at Level 1 and
Level 2 covered institutions. Thus, for both Level 1 and Level 2 parent
institutions the current composition of their deferred compensation
appears to conform to the proposed rule requirements with respect to
equity-like instruments, but only a few Level 1 and Level 2 parent
institutions appear to conform to the proposed rule requirements with
respect to deferral of cash.
    Some of the other requirements and prohibitions for Level 1 and
Level 2 covered institutions in the proposed rule are also currently in
place at the parent institutions of covered BDs. For example, all of
the Level 1 parent institutions and a large majority of Level 2 parent
institutions require that the incentive-based compensation awards of
NEOs be subject to clawback and forfeiture provisions. The frequency of
the use of clawback and forfeiture by Level 1 and Level 2 parent
institutions is higher than that reported by a commenter \380\ based on
the results of a study.\381\ The commenter did not specify, however,
when the study was done, nor the number and type of companies covered
by the study.
---------------------------------------------------------------------------

    \380\ All references to commenters in this economic analysis
refer to comments received on the 2011 Proposed Rule.
    \381\ See comment letter from Financial Services Roundtable (May
31, 2011). The Roundtable conducted a study of a portion of its
membership. Data was collected on the risk management strategies and
the procedures for determining compensation since 2008.
---------------------------------------------------------------------------

    A majority of parent institutions also have prohibitions on
hedging.\382\ Consistent with the proposed prohibition of relying
solely on relative performance measures when awarding incentive-based
compensation, all of the Level 1 and Level 2 parent institutions
currently use a mix of absolute and relative performance measures in
their incentive-based compensation arrangements. Additionally, most
Level 1 parent institutions prohibit acceleration of compensation
payments except in the cases of death or disability, whereas very few
Level 2 parent institutions do that. The average maximum incentive-
based compensation opportunity is 155 percent of the target amount for
Level 1 parent institutions and 190 percent for Level 2 parent
institutions, which is above what would be permitted by the proposed
rules. In the SEC's analysis of the compensation disclosure, the SEC
did not find any mention about prohibition of volume-driven incentive-
based compensation as would be proposed by the rule.
---------------------------------------------------------------------------

    \382\ The proposed rule would prohibit covered institutions from
purchasing hedging instruments on behalf of covered persons. The
statistics regarding hedging prohibitions presented in Table 7A and
Table 7B, and Table 9A and Table 9B refer to complete prohibition
regarding the use of hedging instruments by senior executives and
directors respectively.
---------------------------------------------------------------------------

    Similar results are obtained when analyzing the current practices
of the Level 1 and Level 2 parent institutions of IAs (Table 7B). All
IA parent institutions defer NEO compensation, on average, for three
years. Almost all parent companies subject incentive-based compensation
of NEOs to clawback and forfeiture and prohibit hedging transactions.

      Table 7B--Current Deferral, Clawback, Forfeiture and Certain
   Prohibitions for NEOs at Level 1 and Level 2 IA Parent Institutions
------------------------------------------------------------------------
                                          Level 1 parent  Level 2 parent
------------------------------------------------------------------------
Number of parent institutions with                    10               6
 available compensation data............
Number of NEOs:
    Total number of NEOs................              53              32
    Average number of NEOs per                         5               5
     institution........................
Deferred compensation:
    Institutions with deferred                      100%            100%
     compensation.......................
    Average percent of deferred
     compensation:......................
        CEO.............................             77%             69%
        Other NEOs......................             71%             68%
    Average number of years deferred....             3.6             3.3
Type of compensation deferred:..........
    Institutions with cash..............             20%             67%
    Institutions with stock.............            100%            100%
    Institutions with bonds.............              0%               0
Clawback and forfeiture:
    Institutions with clawback..........            100%            100%
    Institutions with forfeiture........            100%             83%
Prohibitions:
    Institutions prohibiting hedging....             90%             67%
    Institutions prohibiting volume-                 N/A             N/A
     driven incentive-based compensation
    Institutions prohibiting                         70%              0%
     acceleration of payments but for
     death and disability...............
Maximum incentive-based compensation:
    Average percent.....................            148%            188%
Risk Management:
    Institutions with Risk Committees...            100%            100%
    Institutions with fully independent              80%             89%
     Compensation Committee.............
    Institutions where CROs review                   50%             33%
     compensation packages..............
------------------------------------------------------------------------

    To examine how the use of the proposed rule's requirements and
prohibitions has changed since the financial crisis, in Tables 8A and
8B the SEC reports the use of incentive-based compensation deferral,
clawback, forfeiture, and some of the rule prohibitions by the Level 1
and Level 2 parent institutions of BDs and IAs in year 2007, just prior
to the financial crisis. A comparison with the results in Tables 7A and
7B shows that just prior to the financial crisis Level 1 and Level 2
covered institutions deferred less of NEOs' incentive-based
compensation compared to what they defer nowadays. More importantly,
the use of clawback and forfeiture in 2007 was far less common than it
is now: For example, none of these institutions reported using clawback
arrangements as of year 2007. Additionally, fewer covered institutions
had risk committees in year 2007.

  Table 8A--Deferral, Clawback, Forfeiture and Certain Prohibitions for
     NEOs at Level 1 and Level 2 BD Parent Institutions in Year 2007
------------------------------------------------------------------------
                                          Level 1 parent  Level 2 parent
------------------------------------------------------------------------
Number of parent institutions with                    16               5
 available compensation data............
Number of NEOs:
    Total number of NEOs................             101              26
    Average number of NEOs per                         6               5
     institution........................
Deferred compensation:
    Institutions with deferred                      100%            100%
     compensation.......................
    Average percent of deferred
     compensation:
        CEO.............................             49%             34%
        Other NEOs......................             51%             28%
    Average number of years deferred....             3.3               3
Type of compensation deferred:
    Institutions with cash..............              0%             40%
    Institutions with stock.............            100%            100%
Clawback and forfeiture:
    Institutions with clawback..........              0%              0%
    Institutions with forfeiture........             27%             40%
Prohibitions:
    Institutions prohibiting hedging....             14%              0%
    Institutions prohibiting volume-                 N/A             N/A
     driven incentive-based compensation
    Institutions prohibiting                         67%             20%
     acceleration of payments except in
     case of death and disability.......
Maximum incentive-based compensation:
    Average percent.....................            186%             N/A
Risk Management:
    Institutions with Risk Committees...             60%             20%

    Institutions with fully independent              93%            100%
     Compensation Committee.............
    Institutions where CROs review                    0%              0%
     compensation packages..............
------------------------------------------------------------------------

    Thus, the analysis suggests that following the financial crisis,
most Level 1 and Level 2 parent institutions of BDs and IAs have
adopted to a certain extent some of the provisions and prohibitions
that would be required by the proposed rule.

  Table 8B--Deferral, Clawback, Forfeiture and Certain Prohibitions for
     NEOs at Level 1 and Level 2 IA Parent Institutions in Year 2007
------------------------------------------------------------------------
                                          Level 1 parent  Level 2 parent
------------------------------------------------------------------------
Number of parent institutions with                    10               5
 available compensation data............
Number of NEOs:
    Total number of NEOs................              53              26
    Average number of NEOs per                         5               5
     institution........................
Deferred compensation:
    Institutions with deferred                      100%            100%
     compensation.......................
    Average percent of deferred
     compensation:
        CEO.............................             45%             44%
        Other NEOs......................             53%             33%
    Average number of years deferred:...             3.3             3.5
Type of compensation deferred:
    Institutions with cash..............             20%             40%
    Institutions with stock.............            100%            100%
Clawback and forfeiture:
    Institutions with clawback..........              0%              0%
    Institutions with forfeiture........             40%             40%
Prohibitions:
    Institutions prohibiting hedging....             20%              0%
    Institutions prohibiting volume-                 N/A             N/A
     driven incentive-based compensation
    Institutions prohibiting                         40%            100%
     acceleration of payments but for
     death and disability...............
Maximum incentive-based compensation
 Risk Management:
    Average percent.....................            223%             N/A
    Institutions with Risk Committees...             60%              0%
    Institutions with fully independent             100%            100%
     Compensation Committee.............
    Institutions where CROs review                    0%              0%
     compensation packages..............
------------------------------------------------------------------------

    Table 9A lists the most frequent triggers for clawback and
forfeiture, which include some type of misconduct and adverse
performance/outcome. About 19 percent of Level 1 parent institutions
use improper or excessive risk-taking as a trigger for forfeiture and
clawback. About 88 percent of Level 1 parent institutions use
misconduct, and 75 percent of Level 1 parent institutions also use
adverse performance as triggers for clawback, similar to the proposed
rules.

                   Table 9A--Percentage of Level 1, Level 2, and Level 3 BD Parent Institutions by Trigger for Forfeiture and Clawback
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                  Level 1 parents                 Level 2 parents                 Level 3 parents
                                                         -----------------------------------------------------------------------------------------------
                         Trigger                           Forfeiture: %  Clawback: % of   Forfeiture: %  Clawback: % of   Forfeiture: %  Clawback: % of
                                                             of firms          firms         of firms          firms         of firms          firms
--------------------------------------------------------------------------------------------------------------------------------------------------------
Adverse performance/outcome.............................              75              75              20              20               0               9
Misconduct/gross/detrimental conduct....................              88              88              40              60              57              63
Improper/excessive risk-taking..........................              19              19               0               0              14              18
Managerial failure......................................               6               6               0               0               0               0
Restatement/inaccurate reporting........................              19              19              40              60              71              73
Voluntary resignation/retirement........................              13              13               0               0               0               0
Misuse of confidential information/competitive activity.  ..............  ..............  ..............  ..............              29               0
Policy/regulatory breach................................               6               6               0               0               0               0
For-cause termination...................................               6               6               0              20              14               0

Number of parent institutions with available                          16  ..............               5  ..............              13  ..............
 compensation data......................................
--------------------------------------------------------------------------------------------------------------------------------------------------------

    The use of forfeiture and clawback triggers is similar for IA
parent institutions, as Table 9B shows. A significant number of Level 1
parent institutions use adverse performance and misconduct as triggers
for both clawback and forfeiture.

          Table 9B--Triggers for Forfeiture and Clawback of Level 1 and Level 2 IA Parent Institutions
----------------------------------------------------------------------------------------------------------------
                                                          Level 1 parents                 Level 2 parents
                                                 ---------------------------------------------------------------
                     Trigger                       Forfeiture: %  Clawback: % of   Forfeiture: %  Clawback: % of
                                                     of firms          firms         of firms          firms
----------------------------------------------------------------------------------------------------------------
Adverse performance/outcome.....................              80              80              33              33
Misconduct/gross/detrimental conduct............              60              70              50              67
Improper/excessive risk-taking..................              40              40              17              17
Managerial failure..............................               0               0               0              17
Restatement/inaccurate reporting................              10              30              33              50
Misuse of confidential information/competitive                10              10              33              17
 activity.......................................
For-cause termination...........................              10              10              33              17
Number of parent institutions with available                  10  ..............               6  ..............
 compensation data..............................
----------------------------------------------------------------------------------------------------------------

    Some of the provisions of the proposed rule (e.g., prohibition of
hedging) would apply to covered persons that are non-employee directors
who receive incentive-based compensation at Level 1 and Level 2 covered
institutions. Table 10A presents summary statistics on the current
compensation practices of Level 1, Level 2, and Level 3 parent public
institutions of BDs with respect to their non-employee directors. The
data shows that most of the Level 1 parent institutions and all of the
Level 2 parent institutions provide incentive-based compensation to
their non-employee directors, and this compensation comes mainly in the
form of deferred equity. Additionally, a large percentage of both Level
1 and Level 2 parents prohibit hedging by non-employee directors.

                 Table 10A--Incentive-Based Compensation of Non-Employee Directors of BD Parents
----------------------------------------------------------------------------------------------------------------
                                        Level 1 parents            Level 2 parents           Level 3 parents
----------------------------------------------------------------------------------------------------------------
Percentage of institutions with    77%......................  100%....................  100%.
 non-employee directors receiving
 IBC.
Non-employee director IBC as       56%......................  46%.....................  55%.
 percentage of total compensation.
Type of IBC:
    Deferred equity..............  90%......................  100%....................  100%.
    Options......................  10%......................  50%.....................  8%.
Vesting (average number of years)  2.6 years................  2.3 years...............  1.9 years.
Percentage of institutions         70%......................  100%....................  25%.
 prohibiting hedging by non-
 employee directors.
----------------------------------------------------------------------------------------------------------------

    The analysis of non-employee director compensation at the Level 1
and Level 2 parent institutions of IAs in Table 10B shows similar
results: In all of the parent institutions non-employee directors
receive incentive-based compensation and a significant fraction of
parent institutions prohibit hedging transactions related to incentive-
based compensation.

 Table 10B--Incentive-Based Compensation of Non-Employee Directors of IA
                                 Parents
------------------------------------------------------------------------
                                     Level 1               Level 2
------------------------------------------------------------------------
Percentage of institutions    100%................  100%.
 with non-employee directors
 receiving IBC.
Non-employee director IBC as  56%.................  46%.
 percentage of total
 compensation.
Type of IBC:
    Deferred equity.........  90%.................  100%.
    Options.................  0%..................  17%.
Vesting (average number of    1.5 years...........  1.6 years.
 years).
Percentage of institutions    78%.................  83%.
 prohibiting hedging by non-
 employee directors.
------------------------------------------------------------------------

ii. Executives Other Than Named Executive Officers
    While the above statistics are based on publicly disclosed
information on compensation for the five most highly compensated
executive officers at parent institutions, the proposed rule would
apply to any executive officer, employee, director or principal
shareholder (covered persons) who receives incentive-based
compensation. Thus, the data presented above may not be representative
for non-NEOs. To provide some evidence on the current incentive-based
compensation arrangements of non-NEOs, the SEC uses anonymized
supervisory data from the Board. It should be noted that the
composition of the supervisory data sample could be different than that
of the Level 1 and Level 2 parent institutions analyzed above. To
alleviate this potential selection problem, Table 10 compares NEO and
non-NEO compensation arrangements only for the supervisory data sample.
Also, the supervisory data comes from banks, while the data above is
from bank holding companies. Because there may be differences in
incentive-based compensation arrangements and policies at the bank
level and the bank holding company level, the supervisory data analysis
could yield different results compared to the results presented in the
tables above.
    Since the supervisory data does not identify NEOs and non-NEOs but
identifies the managerial position of each executive, the SEC uses an
indirect approach to separate the two groups of executives. From the
proxy statements of Level 1 and Level 2 parent institutions, the SEC
identifies the executives that are most often included in the
definition of NEOs, in addition to the CEO and the CFO. These
executives are the COO, the GC, and often the heads of wealth
management or investment banking. The SEC then classifies these
executives as NEOs and any other executive as non-NEO. Table 11
presents summary statistics for NEOs and non-NEOs based on the
supervisory data.
    Similar to NEOs, non-NEOs tend to have a significant fraction of
long-term incentive compensation in the form of restricted stock units
(``RSUs'') and performance stock units (``PSUs'') that is deferred on
average for about three years. Only 36 percent of institutions in the
sample used cash as incentive-based compensation for non-NEOs and a
significant fraction (on average about 50 percent across institutions
that use cash as incentive-based compensation) of the cash incentive-
based compensation is deferred. Similarly, 45 percent of the deferred
incentive-based compensation for non-NEOs was in the form of restricted
stock and 54 percent was in the form of performance share units. Fifty
percent of the institutions in the sample used options as incentive-
based compensation for non-NEOs, with average vesting period of
approximately 3.7 years.

                   Table 11--Existing Compensation Arrangements for NEO and Non-NEO Executives
----------------------------------------------------------------------------------------------------------------
                                              Non-NEOs                                    NEOs
----------------------------------------------------------------------------------------------------------------
Number of institutions with   14......................................  14.
 available compensation data.
Number of executives........  112.....................................  50.
ST IC/total IC..............  41%.....................................  40%.
Deferred IC/total IC........  60%.....................................  64%.
Options/total IC............  12%.....................................  13%.
percent of institutions with  70%.....................................  70%.
 options.
Deferred IC subject to        57%.....................................  61%.
 clawback and forfeit/
 deferred IC.
Types of IC compensation
 used:
Cash:
    percent of institutions   36%.....................................  36%.
     using cash.
    cash as percent of        48%.....................................  50%.
     deferred IC.
    length of vesting.......  3 years.................................  3 years.
    type of vesting.........  40% immediate, 60% pro-rata.............  40% immediate, 60% pro-rata.
RSUs:
    percent of institutions   64%.....................................  64%.
     using RSUs.
    RSU as percent of         45%.....................................  47%.
     deferred IC.
    length of vesting.......  3.2 years...............................  3.2 years.
    type of vesting.........  11% immediate, 89% pro-rata.............  11% immediate, 89% pro-rata.
PSUs:
    percent of institutions   64%.....................................  64%.
     using PSUs.
    PSU as percent of         54%.....................................  56%.
     deferred IC.
    performance period......  3 years.................................  3 years.
    length of vesting.......  3 years.................................  3 years.
    type of vesting.........  78% immediate, 22% pro-rata.............  78% immediate, 22% pro-rata.
Options:
    percent of institutions   50%.....................................  50%.
     using options.
    Options as percent of     18%.....................................  19%.
     deferred IC.
    length of vesting.......  3.7 years...............................  3.7 years.
    type of vesting.........  100% pro-rata...........................  100% pro-rata.
----------------------------------------------------------------------------------------------------------------

iii. Significant Risk-Takers
    The proposed rule requirements also would apply to significant
risk-takers who receive incentive-based compensation. Because data on
the compensation of significant risk-takers is not publicly available,
the SEC relies on bank supervisory data from the OCC to provide some
evidence on the current practices regarding significant risk-taker
compensation at covered institutions. In the OCC anonymized data, banks
identify material risk-takers and specific compensation arrangements
for them. The definition of a material risk-taker is similar, but not
identical, to that of a significant risk-taker in the proposed rule.
Based on supervisory data from three Level 2 covered institutions, it
seems that the incentive-based compensation of material risk-takers is
subject to deferral, clawback and forfeiture. The fraction of
incentive-based compensation that is subject to deferral depends on the
size of the compensation a material risk-taker

receives. As Table 12 suggests, the percentage deferred varies, with
some exceptions, from 40 percent to 60 percent. The average length of
the deferral period is three years.

            Table 12--Deferral Policy for Material Risk-Takers at Three Level 2 Covered Institutions
----------------------------------------------------------------------------------------------------------------
                                                                                Length of
             Institutions                     Deferral percent            Forfeiture/clawback        deferral
                                                                                (years)
----------------------------------------------------------------------------------------------------------------
Institution 1........................  40%-60%......................  Yes.......................               3
Institution 2........................  40%..........................  Yes.......................               3
Institution 3........................  10%-40%, 40% if bonus          Yes.......................               3
                                        >$750,000.
----------------------------------------------------------------------------------------------------------------

    Due to the lack of data, the SEC is unable to shed light on current
significant risk-taker compensation practices with respect to some of
the other proposed rule requirements such as the use of hedging or the
type of compensation that is being deferred (cash vs. stock vs.
options). In addition, the data is based on information from only three
Level 2 covered institutions. It is also worth noting that the OCC data
is at the bank subsidiary level, not the depository institution holding
company level. Thus, it is possible that the features of the
compensation of significant risk-takers at the bank subsidiary level
may not be representative of the compensation of significant risk-
takers at BDs and IAs.
iv. Covered Persons at Subsidiaries
    Economic theory suggests that, in large, complex, and
interconnected financial institutions that are perceived to receive
implicit government guarantee, managers of these institutions could
have the incentive to take on more risk than they would have taken had
there been no implicit government backstops, thus creating negative
externalities for taxpayers. As discussed above, the proposed rule
could decrease the likelihood of such negative externalities. To the
extent that certain BDs and IAs pose high risk that may lead to
externalities, covered persons likely would therefore include those
individuals who, by virtue of receiving incentive-based compensation,
are in a position of placing significant risks.
    Under the proposed rule, senior executive officers and significant
risk-takers of BDs and IAs that are covered institutions would be
considered covered persons. The proposed rule would require
consolidation of subsidiaries of BHCs that are themselves covered
institutions for the purpose of applying certain rule requirements and
prohibitions to covered persons. As a result of this proposed
consolidation, covered persons employed at BDs and IAs would be subject
to the same requirements as the covered persons of their parent
institutions, even though the BDs and IAs may be of a smaller size, and
hence otherwise treated at a lower level, than their parent
institutions. This proposed consolidation would significantly affect
unconsolidated Level 3 BDs because most of them are held by Level 1 and
Level 2 covered institutions, as well as Level 3 IAs that are held by
Level 1 and Level 2 covered institutions. The proposed consolidation
would also affect unconsolidated Level 2 BDs and IAs that are held by
Level 1 covered institutions because those BDs and IAs will also become
Level 1 covered institutions for the purposes of the rule.
    As of December 2014, there were 29 unconsolidated Level 3 BDs whose
parent institutions are Level 1 and Level 2 institutions (Table 3);
only one of those parent institutions was not a covered institution as
defined by the rule. Additionally, there were 38 unconsolidated Level 3
BDs whose parents were private institutions; while it is possible that
some of these may be Level 1 or Level 2 institutions, the SEC lacks
data to determine their size. With respect to the proposed rule
requirements, the current compensation arrangements of NEOs of Level 3
parent institutions exhibit some important differences compared to
Level 1 and Level 2 parent institutions. For example, Level 3 parent
institutions typically defer a smaller fraction of NEOs' incentive-
based compensation (Table 7A), defer cash less frequently (Table 7A),
and tend to use more options as part of their incentive-based
compensation arrangements (Table 6A), compared to Level 1 and Level 2
parent institutions. On the other hand, Level 3 covered institutions,
like Level 1 and Level 2 covered institutions, tend to apply forfeiture
and clawback and prohibit hedging (Table 7A).
    The proposed rule also would require consolidation with respect to
certain significant risk-takers. Under the proposed definition of
significant risk-taker, employees of a subsidiary that could put
substantial capital of the parent institution at risk would be deemed
significant risk-takers of the parent institution, and the proposed
rule requirements would apply to them in the same manner as the
significant risk-taker at their parent institutions. Because data on
the compensation of significant risk-takers is not publicly available,
the SEC relies on bank supervisory data from the OCC regarding the
current compensation practices for significant risk-takers at Level 3
financial institutions; the SEC does not have data on the compensation
arrangements at Level 1 and Level 2 institutions. Table 13 shows
summary statistics for the compensation arrangements of significant
risk-takers at Level 3 covered institutions. The compensation
arrangements of significant risk-takers of Level 3 covered institutions
seem similar to those of NEOs of Level 3 covered institutions. It is
also worth noting that the OCC data is at the bank subsidiary level,
not the depository institution holding company level. Thus, it is
possible that the features of the compensation of significant risk-
takers at the bank subsidiary level may not be representative of the
compensation of significant risk-takers at BDs and IAs.

Table 13--Existing Compensation Arrangements for Significant Risk-Takers
                     of Level 3 Covered Institutions
------------------------------------------------------------------------
                                        Significant risk-takers
------------------------------------------------------------------------
Number of institutions with    5.
 available compensation data.

ST IC/total IC...............  77%.
Deferred IC/total IC.........  23%.
Deferred IC subject to         89%.
 clawback and forfeit/
 deferred IC.
Types of IC compensation
 used:
Cash:
    percent of institutions    80%.
     using cash.
    cash as percent of         22%.
     deferred IC.
    length of vesting........  0.33 years.
    type of vesting..........  100% pro-rata.
RSUs:
    percent of institutions    100%.
     using RSUs.
    RSU as percent of          31%.
     deferred IC.
    length of vesting........  3 years.
    type of vesting..........  40% immediate, 60% pro-rata.
PSUs:
    percent of institutions    80%.
     using PSUs.
    PSU as percent of          12%.
     deferred IC.
    performance period.......  1.9 years.
    length of vesting........  3 years.
    type of vesting..........  80% immediate, 20% pro-rata.
Options:
    percent of institutions    20%.
     using options.
    Options as percent of      25%.
     deferred IC.
    length of vesting........  NA.
    type of vesting..........  NA.
------------------------------------------------------------------------

3. Regulatory Baseline
    The existing regulatory environment, especially after the financial
crisis of 2007-2008, is also relevant to the current compensation
practices of covered institutions and the effects of the proposed
rulemaking. Several guidance and codes that specifically target
incentive-based compensation have been adopted by various financial
regulators that may also apply to some BDs and IAs. Some of those
prescribe compensation practices and suggest prohibitions that are
similar to the requirements and prohibitions in the proposed rules.
i. Guidance on Sound Incentive Compensation Policies
    In June 2010, the U.S. Federal Banking Agencies \383\ adopted the
Guidance on Sound Incentive Compensation Policies.\384\ The guidance
applies to banking institutions and, because most of the parents of
Level 1 and Level 2 BDs are bank holding companies subject to the
guidance, its principles may apply to these BDs as well if the
compensation structures at subsidiaries are similar to those at the
parent institutions and the parent institution determines to implement
relatively uniform incentive-based compensation policies for the
consolidated institution. The guidance may also apply to the 39 IAs
that are affiliated with banks and thrift institutions with assets of
more than $50 billion.
---------------------------------------------------------------------------

    \383\ The Federal Banking Agencies, as of 2010, were the Board,
OCC, FDIC, and Office of Thrift Supervision.
    \384\ See, 2010 Federal Banking Agency Guidance, available at:
http://www.federalreserve.gov/newsevents/press/bcreg/20100621a.htm.
---------------------------------------------------------------------------

    The guidance is designed to prevent incentive-based compensation
policies at banking institutions from encouraging imprudent risk-taking
and to aid in the development of incentive-based compensation policies
that are consistent with the safety and soundness of the institution.
It has three key principles providing that compensation arrangements at
a banking institution should: (a) Provide employees with incentives
that appropriately balance risk and reward; (b) be compatible with
effective risk management and controls; and (c) be supported by strong
corporate governance, including active and effective oversight by the
institution's board of directors. Similar to the proposed rules, this
guidance applies to senior executives and other employees who, either
individually or as a part of a group, have the ability to expose the
relevant banking institution to a material level of risk. The guidance
suggests several methods of balancing risk and rewards: Risk adjustment
of awards; deferral of payment; longer performance periods; and reduced
sensitivity to short-term performance.
ii. UK Prudential Regulatory Authority Remuneration Code
    The SEC notes that for BDs and IAs whose parents are regulated by
foreign authorities, the foreign regulatory framework with respect to
incentive-based compensation may also be relevant for compliance with
the proposed rules.\385\ For example, in 2010, the UK PRA adopted four
remuneration codes that apply to banks and investment firms and share
important similarities with the proposed rules.\386\ For instance, the
SYSC 19A remuneration code imposes a deferral of at least 40 percent
for not less than 3-5 years. For higher earners, at least 60 percent
has to be deferred. The code applies to senior management, risk takers,
staff engaged in control functions, and any employee receiving
compensation that takes them into the same income bracket as senior
management and risk takers, whose professional activities have a
material impact on the firm's risk profile. The code also requires that
at least 50 percent of any bonus must be made in shares, share-linked
instruments or

other equivalent non-cash instruments of the firm. These shares should
be subject to an appropriate retention period. Firms also need to
disclose details of their remuneration policies at least annually.
---------------------------------------------------------------------------

    \385\ For example, 3 Level 1 and Level 2 BDs have parent
institutions that are subject to the UK PRA rules.
    \386\ There are four codes: SYSC 19A (covering Deposit Taker and
Investment firms), SYSC 19B (covering Alternative Investment Fund
Managers), SYSC 19C--BIPRU (covering Investment firms), and SYSC 19D
(covering Dual-regulated firms Remuneration Code). See https://www.the-fca.org.uk/remuneration.
---------------------------------------------------------------------------

    In July 2014, the Prudential Regulation Authority (PRA) and
Financial Conduct Authority (FCA) published two joint consultation
papers ``aimed at improving individual responsibility and
accountability in the banking sector.'' \387\ The papers seek feedback
on proposed changes to the rules for remuneration for UK banks and PRA-
designated investment firms.\388\ The PRA and FCA's new proposed rules
follow recommendations made by the UK Parliamentary Commission on
Banking Standards, ``Changing Banking for Good,'' published in June
2013, and are a response to the major role played by banks in the
financial crisis in 2007-2008 and allegations of the attempted
manipulation of LIBOR. Their new proposed rules were deemed necessary
because the current rule on individual accountability is ``often
unclear or confused'' \389\ and thus undermines public trust in the
banking sector and the financial regulators. The PRA and FCA proposed
that banks defer bonuses for a minimum of 7 years for senior managers
and 5 years for other material risk-takers. Financial institutions
would be able to recover variable pay even if it was paid out or vested
for up to 7 years after the award date.
---------------------------------------------------------------------------

    \387\ See ``Prudential Regulation Authority and Financial
Conduct Authority Consult on Proposals to Improve Responsibility and
Accountability in the Banking Sector,'' Press Release by the
Financial Conduct Authority, (July 30, 2014), available at: https://www.fca.org.uk/news/pra-and-fca-consult-on-proposals-to-improve-responsibility-and-accountability-in-the-banking-sector.
    \388\ See ``Strengthening Accountability in Banking: A New
Regulatory Framework for Individuals,'' PRA CP14/13, Consultation
Paper, July 2014, available at: https://www.fca.org.uk/news/cp14-13-strengthening-accountability-in-banking. See also, ``Strengthening
the Alignment of Risk and Reward: New Remuneration Rules,'' PRA
CP14/14, Consultation Paper, July 2014, available at: https://www.fca.org.uk/news/cp14-14-strengthening-the-alignment-of-risk-and-reward.
    \389\ See FSA Consultation Paper 14/13: Strengthening
accountability in banking: a new regulatory framework for
individuals (https://www.fca.org.uk/news/cp14-13-strengthening-accountability-in-banking).
---------------------------------------------------------------------------

D. Scope of the Proposed Rule
1. Levels of Covered Institutions
    The proposed rule would create a tiered system of covered
institutions based on an institution's average total consolidated
assets during the most recent consecutive four quarters.\390\ There are
three levels of covered institutions: Level 1, Level 2, and Level 3
covered institutions. Some of the proposed rule requirements (e.g.,
deferral of compensation, forfeiture and clawback) would apply
differentially to covered institutions based on their size tier, with
more stringent restrictions on the incentive-based compensation
arrangements at larger institutions (i.e., Level 1 and Level 2 covered
institutions). In general, the importance of financial institutions in
the economy tends to be positively correlated with their size. This is
apparent from the use of implicit ``too-big-to-fail'' policies by
governments and central banks, providing support to large financial
institutions at times of financial crises because of their importance
to the greater financial system.\391\ In a similar vein, the 2010
Federal Banking Agency Guidance prescribes stricter compensation rules
and related risk-management and corporate governance practices for
large and more complex banking institutions.\392\
---------------------------------------------------------------------------

    \390\ For IAs, the tiered system would be based on year end
balance sheet assets (excluding non-proprietary assets).
    \391\ See, for example, Frederic Mishkin, Financial
Institutions.
    \392\ Large banking institutions include, in the case of banking
institutions supervised by (i) The Board, large, complex banking
institutions as identified by the Board for supervisory purposes;
(ii) the OCC, the largest and most complex national banks as defined
in the Large Bank Supervision booklet of the Comptroller's Handbook;
(iii) the FDIC, large, complex insured depository institutions
(IDIs). See, 2010 Federal Banking Agency Guidance, available at:
http://www.federalreserve.gov/newsevents/press/bcreg/20100621a.htm.
---------------------------------------------------------------------------

    There are various measures developed to estimate the amount of risk
\393\ posed by an institution to the greater financial system. One
study finds that the degree of leverage, maturity mismatch and the size
of the institution are all related to a measure of systemic importance
and risk.\394\ Another study finds that institution size, degree of
leverage and covariance of the institution's stock with the market
during distress are related to the systemic risk contribution of an
institution.\395\ Moreover, an academic study of the financial crisis
states that the size of an institution is likely to magnify the impact
of failure to the entire financial system.\396\ In terms of defining
systemic importance, bank holding companies with assets over $50
billion are required to disclose to the Board on an annual basis, three
indicators related to their systemic risk: Institution size,
interconnectedness and complexity.\397\
---------------------------------------------------------------------------

    \393\ See Bisias et al. 2012. A Survey of Systemic Risk
Analytics. Office of Financial Research, Working Paper.
    \394\ See Adrian, T., Brunnermier, M. 2011. COVAR. American
Economic Review, forthcoming. The paper proposes a measure for
systemic risk contribution by financial institutions. The forward-
looking measure of systemic risk contribution is significantly
related to lagged characteristics of financial institutions such as
size, leverage, and maturity mismatch.
    \395\ See Brownlees, C., Engle, R. 2015. SRISK: A Conditional
Capital Shortfall Index for Systemic Risk Measurement. Working
Paper. The paper develops a measure of systemic risk contribution of
a financial firm. This measure associates systemic risk with the
capital shortfall a financial institution is expected to experience
conditional on a severe market decline. The measure is a function of
the firm's size, degree of leverage and the expected equity loss
conditional on a market downturn.
    \396\ See French et al. 2010. Squam Lake Report: Fixing the
Financial System. Princeton University Press.
    \397\ Size is correlated with the two other measures of systemic
importance, complexity and interconnectedness. See FSOC 2015 Annual
Report, available at: https://www.treasury.gov/initiatives/fsoc/studies-reports/Documents/2015%20FSOC%20Annual%20Report.pdf.
---------------------------------------------------------------------------

    By setting stricter restrictions on the incentive-based
compensation arrangements at Level 1 and Level 2 covered institutions,
the tiered approach could benefit taxpayers. To the extent that
stricter incentive-based compensation rules are effective at curbing
inappropriate risk-taking, this could lessen the default likelihood for
Level 1 and Level 2 covered institutions, thus increasing the
likelihood that taxpayers would not have to incur costs to rescue
important institutions. Moreover, if the stricter incentive-based
compensation rules lower the likelihood of default for Level 1 and
Level 2 covered institutions, the likelihood of default for smaller
institutions could decrease as well, to the extent that smaller
institutions are exposed to counterparty risks due to their connection
with larger Level 1 and Level 2 covered institutions.
    Consolidation requirements aside, the tiered approach also would
not impose as great a compliance burden on smaller Level 3 covered
institutions for which the proposed rule requirements on deferral,
forfeiture and clawback, and some other prohibitions and requirements
do not apply. To the extent that compliance costs have a fixed
component that may have a disproportionate impact on smaller
institutions, excluding Level 3 covered institutions from more
burdensome requirements would not place them at a competitive
disadvantage compared to Level 1 and Level 2 covered institutions.
Moreover, to the extent that executives' incentives become distorted
due to the implicit government guarantee, this is less likely to be the
case for Level 3 covered institutions due to their relatively smaller
size. Thus, the potential benefits of the proposed rule may be less
substantial for smaller covered institutions since such institutions
are less likely to be in a

position to take risks that may lead to externalities.
    However, to the extent that the stricter proposed requirements for
incentive-based compensation arrangements at Level 1 and Level 2
covered institutions induce less than optimal risk-taking incentives
for covered persons from shareholders' point of view, this could result
in a decrease in firm value and hence lower returns for the
shareholders of these institutions. Additionally, the stricter
requirements for Level 1 and Level 2 covered institutions could make it
more difficult to attract and retain human capital, thus creating
competitive disadvantages in the labor market for these institutions.
If these institutions become disadvantaged due to their stricter
compensation requirements, they might be forced to increase overall
compensation to be able to compete for managerial talent with firms
that are not affected by the proposed rules.
    As discussed above, besides an institution's average total
consolidated assets, other indicators (for example, the size of that
institution's open counterparty positions in a market) not perfectly
correlated with size could be a proxy for the importance of financial
institutions to the financial sector and the broader economy. If size
is not a good proxy for the importance of a financial institution, then
the proposed rule would likely pose a disproportionate compliance
burden on larger institutions while not covering institutions that may
be more significant to the overall financial system under different
proxies for importance.
    The proposed thresholds for identifying Level 1 covered
institutions (over $250 billion) and Level 2 covered institutions
(between $50 billion and $250 billion) are similar to those used by
banking regulators in other contexts. For example, the $250 billion is
used by Basel III as a threshold to identify core banks that must adopt
the Basel standards; and the $50 billion threshold is used in a number
of sections of the Dodd-Frank Act.\398\ The use of these two thresholds
might place a higher compliance burden on institutions that, are close
to, but just above the threshold compared to institutions that are
close, but just below the threshold. For example, a BD that has a size
of $49 billion is likely to be similar in many aspects to a BD that has
a size of $51 billion. Yet, with the current cutoff points, the former
would not be subject to deferral, forfeiture and clawback, and other
prohibitions in the proposed rule, while the latter would be.
---------------------------------------------------------------------------

    \398\ For example, sections 165 and 166 of the Dodd-Frank Act
require the Board to establish enhanced prudential standards for
nonbank financial companies supervised by the Board and bank holding
companies with total consolidated assets of $50 billion or more. In
prescribing more stringent prudential standards, the Board may, on
its own or pursuant to a recommendation by the Council in accordance
with section 115, differentiate among companies on an individual
basis or by category, taking into consideration their capital
structure, riskiness, complexity, financial activities (including
the financial activities of their subsidiaries), size, and any other
risk-related factors that the Board deems appropriate.
---------------------------------------------------------------------------

    By covering various types of financial institutions (e.g., banks,
BDs, IAs, thrifts, etc.) with at least $1 billion in assets, section
956 and the proposed rule implicitly assume that larger institutions
pose higher risks, including risks that may impact the financial system
at large. This assumption may not hold true for certain institutions.
For example, in the case of BDs and IAs, which may have a much narrower
scope of activities than a comparably sized commercial bank, the
narrower range of activities could limit their impact on the overall
financial system. On the other hand, larger BDs and IAs may pose higher
risks than smaller BDs and IAs. Also, at least one study has suggested
that the interconnectedness of financial institutions generally could
affect multiple financial institutions in a crisis and impact otherwise
unrelated parts of the larger financial system.\399\ Another study
asserts that financial institutions, including broker-dealers, have
become highly interrelated and less liquid in the past decade, thus
increasing the level of risk in the financial sector.\400\
---------------------------------------------------------------------------

    \399\ See, for example, Bisias D., M. Flood, A.W. Lo, and S.
Valavanis, 2012. A Survey of Systemic Risk Analytics. Office of
Financial Research, Working paper, available at: https://www.treasury.gov/initiatives/wsr/ofr/Documents/OFRwp0001_BisiasFloodLoValavanis_ASurveyOfSystemicRiskAnalytics.pdf.
On page 9, the authors argue that ``In a world of interconnected and
leveraged institutions, shocks can propagate rapidly throughout the
financial network, creating a self-reinforcing dynamic of forced
liquidations and downward pressure on prices.'' The study discusses
the interconnectedness between financial institutions in general and
does not focus on the potential role of BDs and IAs.
    \400\ See Billio M., M. Getmansky, A.W. Lo, and L. Pelizzon.
2012. Econometric Measures of Connectedness and Systemic Risk in the
Finance and Insurance Sectors, Journal of Financial Economics, 104,
535-559. The study examines and finds evidence that banks, brokers,
hedge funds and insurance companies have become highly interrelated
during the last decade, thus increasing the level of systemic risk
in the financial sector. For example, insurance companies have had
little to do with hedge funds until recently when these companies
expanded into markets such as providing insurance for financial
products and credit default swaps. Such activities have potential
implications for systemic risk when conducted on a large scale.
---------------------------------------------------------------------------

2. Senior Executive Officers and Significant Risk-Takers
    The requirements under the proposed rule would place differential
restrictions on compensation arrangements of covered persons. Within
each covered institution, the proposed rule would create different
categories of covered persons, which include any executive officer,
employee, director, or principal shareholder that receives incentive-
based compensation. While the proposed rule would apply to directors or
principal shareholders who receive incentive-based compensation, the
SEC's baseline analysis suggests that most of the parent institutions
provide incentive-based compensation to non-employee directors but none
of them provide such compensation arrangements to principal
shareholders that are neither executives nor non-employee directors.
Below, the SEC focuses the discussion of the economic effects of the
proposed rule on two types of covered persons: Senior executive
officers and significant risk-takers.
    As discussed above, a senior executive officer is defined 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: President, executive chairman, CEO, CFO,
COO, 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 (as defined in the proposed
rule). A significant risk-taker is defined as a covered person, other
than a senior executive officer, who receives compensation of which at
least one-third is incentive-based compensation and is: Either (1)
placed among the highest 5 percent in annual base salary and incentive-
based compensation among all covered persons (excluding senior
executive officers) of a Level 1 covered institution or of any covered
institution affiliate, or (2) placed among the highest 2 percent in
annual base salary and incentive-based compensation among all covered
persons (excluding senior executive officers) of a covered Level 2
covered institution or of any covered institution affiliate, or (3) may
commit or expose 0.5 percent or more of the common equity tier 1
capital, or in the case of a registered securities broker or dealer,
0.5 percent or more of the tentative net capital, of the covered
institution or of any affiliate of the covered institution

that is itself a covered institution, or (4) is designated as a
significant risk-taker by the SEC or the covered institution.
    The proposed rule would impose differential requirements on
compensation arrangements of senior executive officers and significant
risk-takers conditional on the size of the covered institution.
Regarding senior executive officers, at least 60 percent of a senior
executive officer's incentive-based compensation would be required to
be deferred at a Level 1 covered institution, whereas 50 percent would
be the minimum deferral amount for a senior executive officer at a
Level 2 covered institution. Regarding significant risk-takers, 50
percent of a significant-risk-taker's incentive-based compensation at a
Level 1 covered institution would be required to be deferred as
compared to 40 percent for a significant risk-taker's incentive-based
compensation at a Level 2 covered institution. Moreover, the minimum
deferral period for all covered persons at Level 1 covered institutions
would be four years for qualifying incentive-based compensation and two
years for incentive-based compensation received under long-term
incentive plans whereas the deferral period for covered persons at a
Level 2 covered institution would be three years for qualifying
incentive-based compensation and one year for compensation received
under long-term incentive plans.
    In general, the proposed rule would impose relatively stricter
requirements for compensation arrangements of individuals who are more
likely to be in a position to execute or authorize actions with
accompanying risks that may have a significant impact on the financial
health of the covered institution or of any covered institution
affiliate. Specifically, the proposed rule would require a higher
percentage of incentive-based compensation to be deferred for senior
executive officers compared to significant risk-takers at covered
institutions. If senior executive officers are in a position to make
decisions that have a more significant impact on the degree of risk a
covered institution takes than significant risk-takers, then the higher
percentages of deferral amounts for senior executive officers appear to
be commensurate with the degree of inappropriate risk-taking in which
they could engage. This would likely provide proportionately stronger
disincentives for inappropriate risk-taking by individuals that are
more likely to be able to expose the covered institution to greater
amounts of risk, thus potentially benefiting taxpayers and other
stakeholders. In general, if certain significant risk-takers (e.g.,
traders with the ability to place significant bets that could endanger
the financial health of the covered institution or of any affiliate of
the covered institution) could engage in more or similarly significant
risk-taking than senior executive officers, the proposed rules would
place less stringent requirements on the compensation arrangements of
such significant risk-takers compared to senior executive officers,
lowering risk-taking disincentives for significant risk-takers and/or
imposing a potential higher cost to senior executive officers. However,
the proposed rules may also create an incentive for senior executive
officers to monitor significant risk-takers in those situations when
they do not directly supervise such significant risk-takers.
    While the definition of senior executive officer would be primarily
based on job function, the definition of significant risk-taker would
be based on multiple criteria. To identify significant risk-takers, one
direct approach would require knowledge of their authority to expose
their institution to material amounts of risk. This risk-based approach
has intuitive appeal because it relates the application of the rules to
the potential for risk taking. Such an approach could, however, be
designed in many different ways, including differences relating to
determining the appropriate risk-based measure, whether it should be
applied to individuals or a group (e.g., a trader or a trading desk),
and whether it would be appropriate to subject all trading activity to
the same risk-based measure (e.g., U.S. treasury securities versus
collateralized mortgage obligations). One of the criteria in the
definition of significant risk-takers in the proposed rules is based on
individuals' relative size of annual base salary and incentive-based
compensation within a covered institution and its affiliates. If the
highest paid individuals at BDs and IAs are the ones that could place
BDs and IAs, or their parent institutions, at risk of insolvency, then
the use of this criterion is likely to reasonably identify individuals
that are significant risk-takers and as a result lower the likelihood
of inappropriate risks being undertaken and potentially safeguard the
health of these institutions and the broader economy. If, however, the
highest paid individuals at BDs and IAs are not likely to be able to
expose their parent institution to significant risks, this criterion
may be overly inclusive, resulting in individuals being designated as
significant risk-takers without possessing the ability to inflict
substantial losses on BDs or IAs, or their parent institutions. This
may impose restrictions on the compensation of those individuals and as
a consequence may put BDs and IAs at a disadvantage in hiring or
retaining human capital. BDs and IAs may have to increase the
compensation of affected individuals to offset the restrictions imposed
by the proposed rule.
    For IAs that are covered institutions in another capacity and BDs,
the proposed rules would also identify significant risk-takers using a
measure of their ability to expose the covered institution to risks.
More specifically, a person that receives compensation of which at
least one-third is incentive-based compensation and may commit or
expose 0.5 percent or more of the common equity tier 1 capital, or in
the case of a registered securities broker or dealer, 0.5 percent or
more of the tentative net capital, of the covered institution or of any
affiliate of the covered institution would be a significant risk-taker.
As discussed above, the Agencies are proposing the exposure test
because individuals who have the authority to expose covered
institutions to significant amounts of risk can cause material
financial losses to covered institutions. For example, in proposing the
exposure test, the Agencies were cognizant of the significant losses
caused by actions of individuals, or a trading group, at some of the
largest financial institutions during and after the financial crisis
that began in 2007. In the case of a covered institution that is a
subsidiary of another covered institution and is smaller than its
parent, this particular criterion of the significant risk-taker
definition could result in individuals being classified as significant
risk-takers who do not have the ability to expose significant amounts
of the parent's capital to risk.
    Additionally, under the proposed definition of significant risk-
taker, a covered person of a BD or IA subsidiary of a parent
institution that is a Level 1 or Level 2 covered institution may be
designated as a significant risk-taker relative to: (i) In the case of
a BD subsidiary, the size of the BD's tentative net capital or; (ii) in
the case of both BD and IA subsidiaries, the tentative net capital or
common equity tier 1 capital of any section 956 affiliate of the BD or
IA, if the covered person has the ability to commit capital of the
affiliate, even if the BD or IA subsidiary has significantly fewer
assets than its parent. Because the BD subsidiary would be treated as a
Level 1 or Level 2 covered institution due to its parent, a covered
person of a BD that is a

relatively smaller subsidiary would be subject to more stringent
compensation restrictions than would an employee of a comparably sized
BD that is not a subsidiary of a Level 1 or Level 2 covered
institution. As a consequence, if such a designated significant risk-
taker of a smaller BD subsidiary of a Level 1 or Level 2 covered
institution is not in a position to undertake actions that place the
entire institution at risk, then the proposed approach may impose
disproportionately stricter compensation restrictions on such covered
person.
    An alternative would be to use an individual's level of
compensation as a proxy for his or her ability or authority to
undertake risks within a corporate structure. The main assumption under
this approach would be that there is a positive link between an
individual's total compensation and that individual's authority to
commit significant amounts of capital at risk at the covered
institution or any affiliate of the covered institution. A benefit of
the total compensation-based approach would be the implementation
simplicity in the identification of significant risk-takers. However,
the main challenge would be the determination of the total compensation
threshold that would appropriately qualify individuals as significant
risk-takers. On one hand, setting the total compensation threshold too
low could impose incentive-based compensation restrictions on
individuals that do not have authority to undertake significant risks.
As a result, it is possible that incentive-based compensation
requirements imposed on individuals that do not have significant risk-
taking authority could lead to a disadvantage in the efforts of the
institutions to attract and retain talent. On the other hand, setting
the total compensation threshold too high could impose incentive-based
compensation restrictions on an incomplete set of significant risk-
takers, limiting the potential benefits of the proposed rule.
3. Consolidation of Subsidiaries