vested incentive-based compensation for senior executive officers and
significant risk-takers, whether it had been deferred before vesting or
paid out immediately upon award, would be required to be subject to
clawback for a period of no less than seven years following the date on
which such incentive-based compensation vests. Clawback would be
exercised under an identified set of circumstances. These circumstances
include situations where a senior executive officer or significant
risk-taker engaged in: (1) Misconduct that resulted in significant
financial or

reputational harm \192\ to the covered institution; (2) fraud; or (3)
intentional misrepresentation of information used to determine the
senior executive officer's or significant risk-taker's incentive-based
compensation.\193\ The clawback provisions would apply to all vested
incentive-based compensation, whether that incentive-based compensation
had been deferred or paid out immediately when awarded. If a Level 1 or
Level 2 covered institution discovers that a senior executive officer
or significant risk-taker was involved in one of the triggering
circumstances during a past performance period, the institution would
potentially be able to recover from that senior executive officer or
significant risk-taker incentive-based compensation that was awarded
for that performance period and has already vested. A covered
institution could require clawback irrespective of whether the senior
executive officer or significant risk-taker was currently employed by
the covered institution.
---------------------------------------------------------------------------

    \192\ As described in the above note 191, reputational impact or
harm of an event related to the actions of covered individuals
refers to a potential weakening of confidence in an institution as
evidenced by negative reactions from customers, shareholders,
bondholders and other creditors, consumer and community groups, the
press, or the general public.
    \193\ As with other provisions in this proposed rule, the
clawback requirement would not apply to incentive-based compensation
plans and arrangements in place at the time the proposed rule is
final because those plans and arrangements would be grandfathered.
---------------------------------------------------------------------------

    The proposed set of triggering circumstances would constitute a
minimum set of outcomes for which covered institutions would be
required to consider recovery of vested incentive-based compensation.
Covered institutions would retain flexibility to include other
circumstances or outcomes that would trigger additional use of such
provisions.
    In addition, while the proposed rule would require the inclusion of
clawback provisions in incentive-based compensation arrangements, the
proposed rule would not require that Level 1 or Level 2 covered
institutions exercise the clawback provision, and the proposed rule
does not prescribe the process that covered institutions should use to
recover vested incentive-based compensation. Facts, circumstances, and
all relevant information should determine whether and to what extent it
is reasonable for a Level 1 or Level 2 covered institution to seek
recovery of any or all vested incentive-based compensation.
    The Agencies recognize that clawback provisions may provide another
effective tool for Level 1 and Level 2 covered institutions to deter
inappropriate risk-taking because it lengthens the time horizons of
incentive-based compensation.\194\ The Agencies are proposing that
vested incentive-based compensation be subject to clawback for up to
seven years. The Agencies are proposing seven years as the length of
the review period because it is slightly longer than the length of the
average business cycle in the United States and is close to the lower
end of the range of average credit cycles.\195\ Also, the Agencies
observe that seven years is consistent with some international
standards.\196\
---------------------------------------------------------------------------

    \194\ See, e.g., Faulkender, Kadyrzhanova, Prabhala, and Senbet,
``Executive Compensation: An Overview of Research on Corporate
Practices and Proposed Reforms,'' 22 Journal of Applied Corporate
Finance 107 (2010) (arguing that clawbacks guard against
compensating executives for luck rather than long-term performance);
Babenko, Bennett, Bizjak and Coles, ``Clawback Provisions,'' working
paper (2015) available at https://wpcarey.asu.edu/sites/default/files/uploads/department-finance/clawbackprovisions.pdf (finding
that the use of clawback provisions are associated with lower
institution risk); Chen, Greene, and Owers, ``The Costs and Benefits
of Clawback Provisions in CEO Compensation,'' 4 Review of Corporate
Finance Studies 108 (2015) (finding that the use of clawback
provisions are associated with higher reporting quality).
    \195\ See supra note 154.
    \196\ See, e.g., PRA, ``Policy Statement PS7/14: Clawback''
(July 2014), available at http://www.bankofengland.co.uk/pra/Documents/publications/ps/2014/ps714.pdf.
---------------------------------------------------------------------------

    By proposing seven years as the length of the review period, the
Agencies intend to encourage institutions to fairly compensate covered
persons and incentivize appropriate risk-taking, while also recognizing
that recovering amounts that have already been paid is more difficult
than reducing compensation that has not yet been paid. The Agencies are
concerned that a clawback period that is too short or one that is too
long, or even infinite, could result in the covered person ignoring or
discounting the effect of the clawback period and accordingly, could be
less effective in balancing risk-taking. Additionally, a very long or
even infinite clawback period may be difficult to implement.
    While the Agencies did not propose a clawback requirement in the
2011 Proposed Rule, mandatory clawback provisions are not a new
concept. Commenters to the 2011 Proposed Rule advocated that the
Agencies adopt measures to allow shareholders (and others) to recover
incentive-based compensation already paid to covered persons. As
discussed above, clawback provisions are now increasingly common at the
largest financial institutions. The largest (and mostly publicly
traded) covered institutions are already subject to a number of
overlapping clawback regimes as a result of statutory
requirements.\197\ Over the past several years, many financial
institutions have further refined such mechanisms.\198\ Most often,
clawbacks allow banking institutions to recoup incentive-based
compensation in cases of financial restatement, misconduct, or poor
financial outcomes. A number of covered institutions have gone beyond
these minimum parameters to include situations where poor risk
management has led to financial or reputational damage to the
firm.\199\ The Agencies were cognizant of these developments in
proposing the clawback provision in section __.7(c).
---------------------------------------------------------------------------

    \197\ See, e.g., section 304 of the Sarbanes-Oxley Act of 2002,
15 U.S.C. 7243; section 111 of the Emergency Economic Stabilization
Act of 2008, 12 U.S.C. 5221; section 210(s) of the Dodd-Frank Act,
12 U.S.C. 5390(s); section 954 of the Dodd-Frank Act, 15 U.S.C. 78j-
4(b).
    \198\ See, e.g., PricewaterhouseCoopers, ``Executive
Compensation: Clawbacks, 2014 Proxy Disclosure Study'' (January
2015), available at http://www.pwc.com/us/en/hr-management/publications/assets/pwc-executive-compensation-clawbacks-2014.pdf;
Compensation Advisory Partners, ``2014 Proxy Season: Changing
Practices in Executive Compensation: Clawback, Hedging, and Pledging
Policies'' (December 17, 2014), available at http://www.capartners.com/uploads/news/id204/capartners.com-capflash-issue62.pdf.
    \199\ See, e.g., JPMorgan Chase & Company 2015 Proxy Statement,
page 56, available at http://files.shareholder.com/downloads/ONE/1425504805x0x820065/4c79f471-36d9-47d4-a0b3-7886b0914c92/JPMC-2015-ProxyStatementl.pdf (where vested compensation is subject to
clawback if, among other things, ``the employee engaged in conduct
detrimental to the Firm that causes material financial or
reputational harm to the Firm'').
---------------------------------------------------------------------------

    The Agencies propose the three triggers referenced above for
several reasons. First, a number of the specified triggers reflect
better practice at covered institutions today.\200\ The factors
triggering clawback are based on existing clawback requirements that
appear in some covered institutions' incentive-based compensation
arrangements. Second, while many of the clawback regulatory regimes
currently in place focus only on accounting restatements or material
misstatements of financial results, the proposed triggers focus more
broadly on risk-related outcomes that are more likely to contribute
meaningfully to the balance of incentive-based compensation
arrangements. Third, the proposed rule would extend coverage of

clawback mechanisms to include additional senior executive officers or
significant risk-takers whose inappropriate risk-taking may not result
in an accounting restatement, but would inflict harm on the covered
institution nonetheless.
---------------------------------------------------------------------------

    \200\ See, e.g., notes 198 and 199. See also Dawn Kopecki, ``JP
Morgan's Drew Forfeits 2 Years' Pay as Managers Ousted,'' Bloomberg
Business (July 13, 2012); Dolia Estevez, ``Pay Slash to Citigroup's
Top Mexican Executive Called `Humiliating,' '' Forbes (March 13,
2014); Eyk Henning, ``Deutsche Bank Cuts Co-CEOs' Compensation,''
Wall Street Journal (March 20, 2015).
---------------------------------------------------------------------------

    This provision would go beyond, but not conflict with, clawback
provisions in other areas of law.\201\ For example, covered
institutions that issue securities also may be subject to clawback
requirements pursuant to statutes administered by the SEC:
---------------------------------------------------------------------------

    \201\ See, e.g., section 304 of the Sarbanes-Oxley Act of 2002,
15 U.S.C. 7243; section 111 of the Emergency Economic Stabilization
Act of 2008, 12 U.S.C. 5221; section 210(s) of the Dodd-Frank Act,
12 U.S.C. 5390(s); section 954 of the Dodd-Frank Act, 15 U.S.C. 78j-
4(b).
---------------------------------------------------------------------------

    [cir] Section 304 of the Sarbanes-Oxley Act of 2002 \202\ provides
that if an issuer is required to prepare an accounting restatement due
to the material noncompliance of the issuer, as a result of misconduct,
with any financial reporting requirements under the securities laws,
the CEO and chief financial officer of the issuer shall reimburse the
issuer for (i) any bonus or other incentive-based or equity-based
compensation received by that person from the issuer during the 12-
month period following the first public issuance or filing with the SEC
(whichever first occurs) of the financial document embodying such
financial reporting requirement and (ii) any profits realized from the
sale of securities of the issuer during that 12-month period.
---------------------------------------------------------------------------

    \202\ 15 U.S.C. 7243.
---------------------------------------------------------------------------

    [cir] Section 954 of the Dodd-Frank Act added Section 10D to the
Securities Exchange Act of 1934.\203\ Specifically, Section 10D(a) of
the Securities Exchange Act requires the SEC to adopt rules directing
the national securities exchanges \204\ and the national securities
associations \205\ to prohibit the listing of any security of an issuer
that is not in compliance with the requirements of Section 10D(b).
Section 10D(b) requires the SEC to adopt rules directing the exchanges
to establish listing standards to require each issuer to develop and
implement a policy providing: (1) For the disclosure of the issuer's
policy on incentive-based compensation that is based on financial
information required to be reported under the securities laws; and (2)
that, in the event that the issuer is required to prepare an accounting
restatement due to the issuer's material noncompliance with any
financial reporting requirement under the securities laws, the issuer
will recover from any of the issuer's current or former executive
officers who received incentive-based compensation (including stock
options awarded as compensation) during the three-year period preceding
the date the issuer is required to prepare the accounting restatement,
based on the erroneous data, in excess of what would have been paid to
the executive officer under the accounting restatement.
---------------------------------------------------------------------------

    \203\ 15 U.S.C. 78a et seq.
    \204\ A ``national securities exchange'' is an exchange
registered as such under section 6 of the Exchange Act (15 U.S.C.
78f). There are currently 18 exchanges registered under Section 6(a)
of the Exchange Act: BATS Exchange, BATS Y-Exchange, BOX Options
Exchange, C2 Options Exchange, Chicago Board Options Exchange,
Chicago Stock Exchange, EDGA Exchange, EDGX Exchange, International
Securities Exchange (``ISE''), ISE Gemini, Miami International
Securities Exchange, NASDAQ OMX BX, NASDAQ OMX PHLX, The NASDAQ
Stock Market, National Stock Exchange, New York Stock Exchange
(``NYSE''), NYSE Arca and NYSE MKT.
    \205\ A ``national securities association'' is an association of
brokers and dealers registered as such under Section 15A of the
Exchange Act (15 U.S.C. 78o-3). The Financial Industry Regulatory
Authority (``FINRA'') is the only association registered with the
SEC under section 15A(a) of the Exchange Act, but FINRA does not
list securities.
---------------------------------------------------------------------------

    The SEC has proposed rules to implement the requirements of
Exchange Act Section 10D.\206\
---------------------------------------------------------------------------

    \206\ Listing Standards for Recovery of Erroneously Awarded
Compensation, Release No. 33-9861 (July 1, 2015), 80 FR 41144 (July
14, 2015).
---------------------------------------------------------------------------

    7.30. The Agencies invite comment on the clawback requirements of
the proposed rule.
    7.31. Is a clawback requirement appropriate in achieving the goals
of section 956? If not, why not?
    7.32. Is the seven-year period appropriate? Why or why not?
    7.33. Are there state contract or employment law requirements that
would conflict with this proposed requirement? Are there challenges
that would be posed by overlapping Federal clawback regimes? Why or why
not?
    7.34. Do the triggers discussed above effectively achieve the goals
of section 956? Should the triggers be based on those contained in
section 954 of the Dodd-Frank Act?
    7.35. Should the Agencies provide additional guidance on the types
of behavior that would constitute misconduct for purposes of section
__.7(c)(1)?
    7.36. Should the rule include a presumption of some amount of
clawback for particularly severe adverse outcomes? Why or why not? If
so, what should be the amount and what would those outcomes be?

Sec.  __.8 Additional Prohibitions for Level 1 and Level 2 Covered
Institutions

    Section __.8 of the proposed rule would establish additional
prohibitions for Level 1 and Level 2 covered institutions to address
practices that, in the view of the Agencies, could encourage
inappropriate risks that could lead to material financial loss at
covered institutions. The Agencies' views are based in part on
supervisory experiences in reviewing and supervising incentive-based
compensation at some covered institutions, as described earlier in this
Supplemental Information section. Under the proposed rule, an
incentive-based compensation arrangement at a Level 1 or Level 2
covered institution would be considered to appropriately balance risk
and reward, as required by section __.4(c)(1) of the proposed rule,
only if the covered institution complies with the prohibitions of
section __.8.

Sec.  __.8(a) Hedging

    Section __.8(a) of the proposed rule would prohibit Level 1 and
Level 2 covered institutions from purchasing hedging instruments or
similar instruments on behalf of covered persons to hedge or offset any
decrease in the value of the covered person's incentive-based
compensation. This prohibition would apply to all covered persons at a
Level 1 or Level 2 covered institution, not just senior executive
officers and significant risk-takers. Personal hedging strategies may
undermine the effect of risk-balancing mechanisms such as deferral,
downward adjustment and forfeiture, or may otherwise negatively affect
the goals of these risk-balancing mechanisms and their overall efficacy
in inhibiting inappropriate risk-taking.\207\ For example, a financial
instrument, such as a derivative security that increases in value as
the price of a covered institution's equity decreases would offset the
intended balancing effect of awarding incentive-based compensation in
the form of equity, the value of which is linked to the performance of
the covered institution.
---------------------------------------------------------------------------

    \207\ This prohibition would not limit a covered institutions
ability to hedge its own exposure in deferred compensation
obligations, which the Board, the OCC, and the FDIC continue to view
as prudent practice. (see, e.g., Federal Reserve SR Letter 04-19
(Dec. 7, 2004); OCC Bulletin 2004-56 (Dec. 7, 2004); FDIC FIL-127-
2004 (Dec. 7, 2004); OCC Interpretive Letter No. 878 (Dec. 22,
1999).
---------------------------------------------------------------------------

    Similarly, a hedging arrangement with a third party, under which
the third party would make direct or indirect payments to a covered
person that are linked to or commensurate with the amounts by which a
covered person's incentive-based compensation is reduced by forfeiture,
would protect the covered person against declines in the value of
incentive-based compensation.

In order for incentive-based compensation to provide the appropriate
incentive effects, covered persons should not be shielded from exposure
to the negative financial impact of taking inappropriate risks or other
aspects of their performance at the covered institution.
    In the 2011 Proposed Rule, the Agencies stated that they were aware
that covered persons who received incentive-based compensation in the
form of equity might wish to use personal hedging strategies as a way
to assure the value of deferred equity compensation.\208\ The Agencies
expressed concern that such hedging during deferral periods could
diminish the alignment between risk and financial rewards that deferral
arrangements might otherwise achieve.\209\ After considering
supervisory experiences in reviewing incentive-based compensation at
some covered institutions and the purposes of section 956 and related
provisions of the Dodd-Frank Act, the Agencies are proposing a
prohibition on covered institutions purchasing hedging and similar
instruments on behalf of a covered person as a practical approach to
eliminate the possibility that hedging during deferral periods could
diminish the alignment between risk and financial rewards that deferral
arrangements might otherwise achieve.
---------------------------------------------------------------------------

    \208\ See 76 FR at 21183.
    \209\ The Agencies note that one commenter to the 2011 Proposed
Rule supported limits on hedging.
---------------------------------------------------------------------------

    8.1. The Agencies invite comment on whether this restriction on
Level 1 and Level 2 covered institutions prohibiting the purchase of a
hedging instrument or similar instrument on behalf of covered persons
is appropriate to implement section 956 of the Dodd-Frank Act.
    8.2. Are there additional requirements that should be imposed on
covered institutions with respect to hedging of the exposure of covered
persons under incentive-based compensation arrangements?
    8.3. Should the proposed rule include a prohibition on the purchase
of a hedging instrument or similar instrument on behalf of covered
persons at Level 3 institutions?

Sec.  __.8(b) Maximum Incentive-Based Compensation Opportunity

    Section __.8(b) of the proposed rule would limit the amount by
which the actual incentive-based compensation awarded to a senior
executive officer or significant risk-taker could exceed the target
amounts for performance measure goals established at the beginning of
the performance period. It is the understanding of the Agencies that,
under current practice, covered institutions generally establish
performance measure goals for their covered persons at the beginning
of, or early in, a performance period. At that time, under some
incentive-based compensation plans, those covered institutions
establish target amounts of incentive-based compensation that the
covered persons can expect to be awarded if they meet the established
performance measure goals. Some covered institutions also set out the
additional amounts of incentive-based compensation, in excess of the
target amounts, that covered persons can expect to be awarded if they
or the covered institution exceed the performance measure goals.
Incentive-based compensation plans commonly set out maximum awards of
150 to 200 percent of the pre-set target amounts.\210\
---------------------------------------------------------------------------

    \210\ See, e.g., Arthur Gallagher & Co., ``Study of 2013 Short-
and Long-Term Incentive Design Criterion Among Top 200 S&P 500
Companies'' (December 5, 2014), available at http://www.ajg.com/media/1420659/study-of-2013-short-and-long-term-incentive-design-criterion-among-top-200.pdf.
---------------------------------------------------------------------------

    The proposed rule would prohibit a Level 1 or Level 2 covered
institution from awarding incentive-based compensation to a senior
executive officer in excess of 125 percent of the target amount for
that incentive-based compensation. For a significant risk-taker the
limit would be 150 percent of the target amount for that incentive-
based compensation. This limitation would apply on a plan-by-plan
basis, and, therefore, would apply to long-term incentive plans
separately from other incentive-based compensation plans.
    For example, a Level 1 covered institution might provide an
incentive-based compensation plan for its senior executive officers
that links the amount awarded to a senior executive officer to the
covered institution's four-year average return on assets (ROA). The
plan could establish a target award amount of $100,000 and a target
four-year average ROA of 75 basis points. That is, if the covered
institution's four-year average ROA was 75 basis points, a senior
executive officer would receive $100,000. The plan could also provide
that senior executive officers would earn nothing (zero percent of
target) under the plan if ROA was less than 50 basis points; $60,000
(60 percent of target) if ROA was 65 basis points; and $125,000 (125
percent of target) if ROA was 100 basis points. Under the proposed
rule, the plan would not be permitted to provide, for example, $130,000
(130 percent of target) if ROA was 100 basis points or $150,000 (150
percent of target) if ROA was 110 basis points.
    The Agencies are proposing these limits, in part, because they are
consistent with the current industry practice at large banking
organizations. Moreover, high levels of upside leverage (e.g., 200
percent to 300 percent above the target amount) could lead to senior
executive officers and significant risk-takers taking inappropriate
risks to maximize the opportunity to double or triple their incentive-
based compensation. Recognizing the potential for inappropriate risk-
taking with such high levels of leverage, the Federal Banking Agencies
have worked with large banking organizations to reduce leverage levels
to a range of 125 percent to 150 percent. Such a range continues to
provide for flexibility in the design and operation of incentive-based
compensation arrangements in covered institutions while it addresses
the potential for inappropriate risk-taking where leverage
opportunities are large or uncapped. For a full example of how these
requirements would work in practice, please see Appendix A of this
Supplementary Information section.
    The proposed rule would set different maximums for senior executive
officers and for significant risk-takers because senior executive
officers and significant risk-takers have the potential to expose
covered institutions to different types and levels of risk, and may be
motivated by different types and amounts of incentive-based
compensation. The Agencies intend the different limitations to reflect
the differences between the risks posed by senior executive officers
and significant risk-takers.
    The Agencies emphasize that the proposed limits on a covered
employee's maximum incentive-based compensation opportunity would not
equate to a ceiling on overall incentive-based compensation. Such
limits would represent only a constraint on the percentage by which
incentive-based compensation could exceed the target amount, and is
aimed at prohibiting the use of particular features of incentive-based
compensation arrangements which can contribute to inappropriate risk-
taking.
    8.4. The Agencies invite comment on whether the proposed rule
should establish different limitations for senior executive officers
and significant risk-takers, or whether the proposed rule should impose
the same percentage limitation on senior executive officers and
significant risk-takers.
    8.5. The Agencies also seek comment on whether setting a limit on
the amount that compensation can grow from the time the target is
established

until an award occurs would achieve the goals of section 956.
    8.6. The Agencies invite comment on the appropriateness of the
limitation, i.e., 125 percent and 150 percent for senior executive
officers and significant risk-takers, respectively. Should the
limitations be set higher or lower and, if so, why?
    8.7. Should the proposed rule apply this limitation on maximum
incentive-based compensation opportunity to Level 3 institutions?

Sec.  __.8(c) Relative Performance Measures

    Under section __.8(c) of the proposed rule, a Level 1 or Level 2
covered institution would be prohibited from using incentive-based
compensation performance measures based solely on industry peer
performance comparisons. This prohibition would apply to incentive-
based compensation arrangements for all covered persons at a Level 1 or
Level 2 covered institution, not just senior executive officers and
significant risk-takers.
    As discussed above, covered institutions generally establish
performance measures for covered persons at the beginning of, or early
in, a performance period. For these types of plans, the performance
measures (sometimes known as performance metrics) are the basis upon
which a covered institution determines the related amounts of
incentive-based compensation to be awarded to covered persons. These
performance measures can be absolute, meaning they are based on the
performance of the covered person or the covered institution without
reference to the performance of other covered persons or covered
institutions. In contrast, a relative performance measure is a
performance measure that compares a covered institution's performance
to that of so called ``peer institutions'' or an industry average. The
composition of peer groups is generally decided by the individual
covered institution. An example of an absolute performance measure is
total shareholder return (TSR). An example of a relative performance
measure is the rank of the covered institution's TSR among the TSRs of
institutions in a pre-established peer group.
    The Agencies have observed that incentive-based compensation
arrangements based solely on industry peer performance comparisons (a
type of relative performance measure) can cause covered persons to take
inappropriate risks that could lead to material financial loss.\211\
For example, if a covered institution falls behind its industry peers,
it may use performance measures--and set goals for those measures--that
lead to inappropriate risk-taking by covered persons in order to
perform better than its industry peers. Also, the performance of a
covered institution can be strong relative to its peers, but poor on an
absolute basis (e.g., every institution in the peer group is performing
poorly, but the covered institution is the best of the group).
Consequently, if incentive-based compensation arrangements were based
only on relative performance measures, they would, in that
circumstance, reward covered employees for performance that is poor on
an absolute level but still better than that of the covered
institution's peer group. Similarly, in cases where only relative
performance measures are used and performance is poor, performance-
based vesting may still occur when peer performance is also poor. Using
a combination of relative and absolute performance measures as part of
the performance evaluation process can help maintain balance between
financial rewards and potential risks in such situations.
---------------------------------------------------------------------------

    \211\ Gong, Li, and Shin, ``Relative Performance Evaluation and
Related Peer Groups in Executive Compensation Contracts,'' 86 The
Accounting Review 1007 (May 2011).
---------------------------------------------------------------------------

    Additionally, covered persons do not know what level of performance
is necessary to meet or exceed target peer group rankings, as rankings
will become known only at the end of the performance period. As a
result, covered employees may be strongly incentivized to achieve
exceptional levels of performance by taking inappropriate risks to
increase the likelihood that the covered institution will meet or
exceed the peer group ranking in order to maximize their incentive-
based compensation.
    Further, comparing an institution's performance to a peer group can
be misleading because the members of the peer group are likely to have
different business models, product mixes, operations in different
geographical locations, cost structures, or other attributes that make
comparisons between institutions inexact.
    Relative performance measures, including industry peer performance
measures, may be useful when used in combination with absolute
performance measures. Thus, under the proposed rule, a covered
institution would be permitted to use relative performance measures in
combination with absolute performance measures, but not in isolation.
For instance, a covered institution would not be in compliance with the
proposed rule if the performance of the CEO were assessed solely on the
basis of total shareholder return relative to a peer group. However, if
the performance of the CEO were assessed on the basis of institution-
specific performance measures, such as earnings per share and return on
tangible common equity, along with the same relative TSR the covered
institution would comply with section __.8(c) of the proposed rule
(assuming the CEO's incentive-based compensation arrangement met the
other requirements of the rule, such as an appropriate balance of risk
and reward).
    8.8. The Agencies invite comment on whether the restricting on the
use of relative performance measures for covered persons at Level 1 and
Level 2 covered institutions in section __.8(d) of the proposed rule is
appropriate in deterring behavior that could put the covered
institution at risk of material financial loss. Should this restriction
be limited to a specific group of covered persons and why? What are the
relative performance measures being used in industry?
    8.9. Should the proposed rule apply this restriction on the use of
relative performance measures to Level 3 institutions?

Sec.  __.8(d) Volume-Driven Incentive-Based Compensation

    Section __.8(d) of the proposed rule would prohibit Level 1 and
Level 2 covered institutions from providing incentive-based
compensation to a covered person that is based solely on transaction or
revenue volume without regard to transaction quality or the compliance
of the covered person with sound risk management. Under the proposed
rule, transaction or revenue volume could be used as a factor in
incentive-based compensation arrangements, but only in combination with
other factors designed to cause covered persons to account for the
risks of their activities. This prohibition would apply to incentive-
based compensation arrangements for all covered persons at a Level 1 or
Level 2 covered institution, not just senior executive officers and
significant risk-takers.
    Incentive-based compensation arrangements that do not account for
the risks covered persons can take to achieve performance measures do
not appropriately balance risk and reward, as section __.4(c)(1) of the
proposed rule would require. An arrangement that provides incentive-
based compensation

to a covered person based solely on transaction or revenue volume,
without regard to other factors, would not adequately account for the
risks to which the transaction in question could expose the covered
institution. For instance, an incentive-based compensation arrangement
that rewarded mortgage originators based solely on the volume of loans
approved, without any subsequent adjustment for the quality of the
loans originated (such as adjustments for early payment default or
problems with representations and warranties) would not adequately
balance risk and financial rewards.
    An incentive-based compensation arrangement with performance
measures based solely on transaction or revenue volume could
incentivize covered persons to generate as many transactions or as much
revenue as possible without appropriate attention to resulting risks.
Such arrangements were noted in MLRs and similar reports where
compensation had been cited as a contributing factor to a financial
institution's failure during the recent financial crisis.\212\ In
addition, many studies about the causes of the recent financial crisis
discuss how volume-driven incentive-based compensation lead to
inappropriate risk-taking and caused material financial loss to
financial institutions.\213\
---------------------------------------------------------------------------

    \212\ In accordance with section 38(k) of the FDIA, 12 U.S.C.
1831o(k), MLRs are conducted by the Inspectors General of the
appropriate Federal banking agency following the failure of insured
depository institutions.
    See, e.g., Office of Inspector General for the Department of
Treasury, ``Material Loss Review of Indymac Bank, FSB,'' OIG-09-032
(February 26, 2009), available at http://www.treasury.gov/about/organizational-structure/ig/Documents/oig09032.pdf; Offices of
Inspector General for the Federal Deposit Insurance Corporation and
the Department of Treasury, ``Evaluation of Federal Regulatory
Oversight of Washington Mutual Bank,'' EVAL-10-002 (April 9, 2010),
available at https://www.fdicig.gov/reports10/10-002EV.pdf.
    \213\ See, e.g., Financial Crisis Inquiry Commission, ``The
Financial Crisis Inquiry Report'' (January 2011), available at
http://fcic-static.law.stanford.edu/cdn_media/fcic-reports/fcic_final_report_full.pdf.
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    8.10. The Agencies invite comment on whether there are
circumstances under which consideration of transaction or revenue
volume as a sole performance measure goal, without consideration of
risk, can be appropriate in incentive-based compensation arrangements
for Level 1 or Level 2 covered institutions.
    8.11. Should the proposed rule apply this restriction on the use of
volume-driven incentive-based compensation arrangements to Level 3
institutions?

Sec.  __.9 Risk Management and Controls Requirements for Level 1 and
Level 2 Covered Institutions

    Prior to the financial crisis that began in 2007, institutions
rarely involved risk management in either the design or monitoring of
incentive-based compensation arrangements. Federal Banking Agency
reviews of compensation practices have shown that one important
development in the intervening years has been the increasing
integration of control functions in compensation design and decision-
making. For instance, control functions are increasingly relied on to
ensure that risk is properly considered in incentive-based compensation
programs. At the largest covered institutions, the role of the board of
directors in oversight of compensation programs (including the
oversight of supporting risk management processes) has also expanded.
    Section __.9 of the proposed rule would establish additional risk
management and controls requirements at Level 1 and Level 2 covered
institutions. Without effective risk management and controls, larger
covered institutions could establish incentive-based compensation
arrangements that, in the view of the Agencies,\214\ could encourage
inappropriate risks that could lead to material financial loss at
covered institutions. Under the proposed rule, an incentive-based
compensation arrangement at a Level 1 or Level 2 covered institution
would be considered to be compatible with effective risk management and
controls, as required by section __.4(c)(2) of the proposed rule, only
if the covered institution also complies with the requirements of
section __.9. In proposing section __.9, the Agencies are also
cognizant of comments received on the 2011 Proposed Rule.\215\ In order
to facilitate consistent adoption of the practices that contribute to
incentive-based compensation arrangements that appropriately balance
risk and reward, the Agencies are proposing that the practices set
forth in section __.9 be required for all Level 1 and Level 2 covered
institutions.
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    \214\ This view is based in part on supervisory experiences in
reviewing and supervising incentive-based compensation at some
covered institutions.
    \215\ The 2011 Proposed Rule would have required incentive-based
compensation arrangements to be compatible with effective risk
management and controls. A number of commenters offered views on the
proposed requirements, and some raised concerns. Some commenters
emphasized the importance of sound risk management practices in the
area of incentive-based compensation. However, a number of
commenters also questioned whether the determination of an
``appropriate'' role for risk management personnel should be left to
the discretion of individual institutions. In light of these
comments, the proposed rule is designed to strike a reasonable
balance between requiring an appropriate role for risk management
and allowing institutions the ability to tailor their risk
management practices to their business model. The proposed rule does
not include prescriptive standards. Instead, it would allow Level 1
and Level 2 covered institutions to retain flexibility to determine
the specific role that risk management and control functions should
play in incentive-based compensation processes, while still allowing
for appropriate oversight of incentive-based compensation
arrangements.
---------------------------------------------------------------------------

    Section __.9(a) of the proposed rule would establish minimum
requirements for a risk management framework at a Level 1 or Level 2
covered institution by requiring that such framework: (1) Be
independent of any lines of business; (2) include an independent
compliance program that provides for internal controls, testing,
monitoring, and training with written policies and procedures
consistent with section __.11 of the proposed rule; and (3) be
commensurate with the size and complexity of the covered institution's
operations.
    Generally, section __.9(a) would require that Level 1 and Level 2
covered institutions have a systematic approach to designing and
implementing their incentive-based compensation arrangements and
incentive-based compensation programs supported by independent risk
management frameworks with written policies and procedures, and
developed systems. These frameworks would include processes and systems
for identifying and reporting deficiencies; establishing managerial and
employee responsibility; and ensuring the independence of control
functions. To be effective, an independent risk management framework
should have sufficient stature, authority, resources and access to the
board of directors.
    Level 1 and Level 2 covered institutions would be required to
develop, as part of their broader risk management framework, an
independent compliance program for incentive-based compensation. The
Federal Banking Agencies have found that an independent compliance
program leads to more robust oversight of incentive-based compensation
programs, helps to avoid undue influence by lines of business, and
facilitates supervision. Agencies would expect such a compliance
program to have formal policies and procedures to support compliance
with the proposed rule and to help to ensure that risk is effectively
taken into account in both design and decision-making processes related
to incentive-based

compensation. The requirements for such policies and procedures are set
forth in section __.11 of the proposed rule.
    The requirements of the proposed rule would encourage Level 1 and
Level 2 covered institutions to develop well-targeted internal controls
that work within the covered institution's broader risk management
framework to support balanced risk-taking. Independent control
functions should regularly monitor and test the covered institution's
incentive-based compensation program and its arrangements to validate
their effectiveness. Training would generally include communication to
employees of the covered institution's compliance risk management
standards and policies and procedures, and communication to managers on
expectations regarding risk adjustment and documentation.
    The Agencies note that independent compliance programs consistent
with these proposed requirements are already in place at a significant
number of larger covered institutions, in part due to supervisory
efforts such as the Board's ongoing horizontal review of incentive-
based compensation,\216\ Enhanced Prudential Standards from section 165
of the Dodd-Frank Act,\217\ and the OCC's Heightened Standards.\218\
For example, control function employees monitor compliance with
policies and procedures and help to ensure robust documentation of
compensation decisions, including those relating to forfeiture and
risk-adjustment processes. Institutions have also improved
communication to managers and employees about how risk adjustment
should work and have developed processes to review the application of
related guidance in order to ensure better consideration of risk in
compensation decisions. The Agencies are proposing to require similar
compliance programs at covered institutions not subject to the
supervisory efforts described above, as well as to reinforce the
practices of covered institutions that already have such compliance
programs in place.
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    \216\ See 2011 FRB White Paper.
    \217\ See 12 CFR part 252.
    \218\ See 12 CFR part 30, appendix D.
---------------------------------------------------------------------------

    Section __.9(b) of the proposed rule would require Level 1 and
Level 2 covered institutions to provide individuals engaged in control
functions with the authority to influence the risk-taking of the
business areas they monitor and to ensure covered persons engaged in
control functions are compensated in accordance with the achievement of
performance objectives linked to their control functions and
independent of the performance of the business areas they oversee.
These protections are intended to mitigate potential conflicts of
interest that might undermine the role covered persons engaged in
control functions play in supporting incentive-based compensation
arrangements that appropriately balance risk and reward.
    Under section__.9(c) of the proposed rule, Level 1 and Level 2
covered institutions would be required to provide for independent
monitoring of: (1) Incentive-based compensation plans to identify
whether those plans appropriately balance risk and reward; (2) events
relating to forfeiture and downward adjustment reviews and decisions
related thereto; and (3) compliance of the incentive-based compensation
program with the covered institution's policies and procedures.
    To be considered independent under the proposed rule, the group or
person at the covered institution responsible for monitoring the areas
described above generally should have a reporting line to senior
management or the board that is separate from the covered persons whom
the group or person is responsible for monitoring. Some covered
institutions may use internal audit to perform the independent
monitoring that would be required under this section.\219\ The type of
independent monitoring conducted to fulfill the requirements of section
__.9(c) generally should be appropriate to the size and complexity of
the covered institution and its use of incentive-based compensation.
For example, a Level 1 covered institution might be expected to use a
different scope and type of data and analysis to monitor its incentive-
based compensation program than a Level 2 covered institution.
Likewise, a covered institution that offers incentive-based
compensation to only a few employees may require a less formal
monitoring process than a covered institution that offers many types of
incentive-based compensation to many of its employees.
---------------------------------------------------------------------------

    \219\ At OCC-supervised institutions, the independent monitoring
required under section __.9(c) would be carried out by internal
audit.
---------------------------------------------------------------------------

    Section __.9(c)(1) of the proposed rule would require covered
institutions to periodically review all incentive-based compensation
plans to assess whether those plans provide incentives that
appropriately balance risk and reward. Monitoring the incentives
embedded in plans, rather than the individual arrangements that rely on
those plans, provides an opportunity to identify incentives for
imprudent risk-taking. It also reduces burden on covered institutions
in a reasonable way in light of the proposed rule's additional
protections against excessive risk-taking which operate at the level of
incentive-based compensation arrangements. Supervisory experience
indicates that many covered institutions already periodically perform
such a review, and the Agencies consider it a better practice. Level 1
and Level 2 covered institutions should have procedures for collecting
information about the effects of their incentive-based compensation
arrangements on employee risk-taking, and have systems and processes
for using this information to adjust incentive-based compensation
arrangements in order to eliminate or reduce unintended incentives for
inappropriate risk-taking.
    Under Section __.9(c)(2), covered institutions would be required to
provide for the independent monitoring of all events related to
forfeiture and downward adjustment. With regard to forfeiture and
downward adjustment decisions, covered institutions would be expected
to regularly monitor the events that could trigger a forfeiture and
downward adjustment review. Many covered institutions also regularly
conduct independent monitoring and testing activities, or broad-based
risk reviews, that could reveal instances of inappropriate risk-taking.
The policies and procedures established under section __.11(b) would be
expected to specify that covered institutions would evaluate whether
inappropriate risk-taking identified in the course of any independent
monitoring and testing activities triggered a forfeiture and downward
adjustment review. The frequency of reviews may vary depending on the
size and complexity of, and the level of risks at, the covered
institution, but they should occur often enough to reasonably monitor
risks and events related to the forfeiture and downward adjustment
triggers.\220\ When these reviews uncover events that trigger
forfeiture and downward adjustment reviews, Level 1 and Level 2 covered
institutions would be required to complete such a review, consistent
with the requirements of section __.7(b). They would also be required
to monitor adherence to policies and procedures that support effective
balancing of risk and rewards. Many covered institutions currently
perform forfeiture reviews in the context of broader and more regular
risk reviews to ensure that the forfeiture review process appropriately
captures all risk-taking activity. The Agencies view this

approach as better practice, as decisions about appropriate adjustment
of compensation in such circumstances are only one desired outcome. For
instance, identification of risk events generally should lead not only
to consideration of compensation adjustments, but also to analysis of
whether there are weaknesses in broader controls or risk management
oversight that need to be addressed. In their supervisory experience,
the Federal Banking Agencies have found that tying forfeiture reviews
to broader risk reviews is a better practice.
---------------------------------------------------------------------------

    \220\ See section __.7(b)(2).
---------------------------------------------------------------------------

    Section __.9(c)(3) of the proposed rule would require covered
institutions to provide for independent compliance monitoring of the
institution's incentive-based compensation program with policies and
procedures. To be considered independent under the proposed rule, the
group or person at the covered institution monitoring compliance should
have a separate reporting line to senior management or to the board of
directors from the business line or group being monitored, but may be
conducted by groups within the covered institution. For example,
internal audit could review whether award disbursement and vesting
policies were adhered to and whether documentation of such decisions
was sufficient to support independent review. Such independence will
help ensure that the monitoring is unbiased and identifies appropriate
issues.
    The Agencies have taken the position that Level 1 and Level 2
covered institutions should regularly review whether the design and
implementation of their incentive-based compensation arrangements
deliver appropriate risk-taking incentives. Independent monitoring
should enable covered institutions to correct deficiencies and make
necessary improvements in a timely fashion based on the results of
those reviews.\221\
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    \221\ The 2010 Federal Banking Agency Guidance mentions several
practices that can contribute to the effectiveness of such activity,
including internal reviews and audits of compliance with policies
and procedures, and monitoring of results relative to expectations.
For instance, internal audit should assess the effectiveness of the
compliance risk management program by performing regular independent
reviews and evaluating whether internal controls, policies, and
processes that limit incentive-based compensation risk are effective
and appropriate for the covered institution's activities and
associated risks.
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    9.1 Some Level 1 and Level 2 covered institutions are subject to
separate risk management and controls requirements under other
statutory or regulatory regimes. For example, OCC-supervised Level 1
and Level 2 covered institution are subject to the OCC's Heightened
Standards. Is it clear to commenters how the risk management and
controls requirements under the proposed rule would interact, if at
all, with requirements under other statutory or regulatory regimes?

Sec.  __.10 Governance Requirements for Level 1 and Level 2 Covered
Institutions

    Section __.10 of the proposed rule contains specific governance
requirements that would apply to Level 1 and Level 2 covered
institutions. Under the proposed rule, an incentive-based compensation
arrangement at a Level 1 or Level 2 covered institution would be
considered to be supported by effective governance, as required by
section __.4(c)(3) of the proposed rule, only if the covered
institution also complies with the requirements of section __.10.
    As discussed earlier in this Supplementary Information section, the
supervisory experience of the Federal Banking Agencies at large
consolidated financial institutions is that effective oversight by a
covered institution's board of directors, including review and approval
by the board of the overall goals and purposes of the covered
institution's incentive-based compensation program, is essential to the
attainment of incentive-based compensation arrangements that do not
encourage inappropriate risks that could lead to material financial
loss to the covered institution.
    Accordingly, section __.10(a) of the proposed rule would require
that a Level 1 or Level 2 covered institution establish a compensation
committee, composed solely of directors who are not senior executive
officers, to assist the board in carrying out its responsibilities
related to incentive-based compensation.\222\ Having an independent
compensation committee is consistent with the emphasis the Agencies
place on the need for incentive-based compensation arrangements to be
compatible with effective risk management and controls and supported by
effective governance. In response to the 2011 Proposed Rule, some
commenters expressed a view that an independent compensation committee
composed solely of non-management directors would have helped to avoid
potential conflicts of interest and more appropriate consideration of
management proposals, particularly proposed awards and payouts for
senior executive officers.
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    \222\ As described above, under the Board's and FDIC's proposed
rules, for a foreign banking organization, ``board of directors''
would mean the relevant oversight body for the institution's U.S.
branch, agency, or operations, consistent with the foreign banking
organization's overall corporate and management structure. The Board
and FDIC will work with foreign banking organizations to determine
the appropriate persons to carry out the required functions of a
compensation committee under the proposed rule. Likewise, under the
OCC's proposed rule, for a Federal branch or agency of a foreign
bank, ``board of directors'' would mean the relevant oversight body
for the Federal branch or agency, consistent with its overall
corporate and management structure. The OCC would work closely with
Federal branches and agencies to determine the person or committee
to undertake the responsibilities assigned to the oversight body.
---------------------------------------------------------------------------

    Section __.10(b) of the proposed rule would require that
compensation committees at Level 1 and Level 2 covered institutions
obtain input and assessments from various parties. For example, the
compensation committees would be required to obtain input on the
effectiveness of risk measures and adjustments used to balance risk and
reward in incentive-based compensation arrangements from the risk and
audit committees of the covered institution's board of directors, or
groups performing similar functions, and from the covered institution's
risk management function. The proposed requirements would help protect
covered institutions against inappropriate risk-taking that could lead
to material financial loss by leveraging the expertise and experience
of these parties.
    In their review of the incentive-based compensation practices of
many of the largest covered institutions, the Federal Banking Agencies
have noted that the compensation, risk, and audit committees of the
boards of directors collaborate and seek advice from risk management
and other control functions before making decisions. Many of these
covered institutions have members of the compensation committee that
are also members of the risk and audit committees. Some covered
institutions rely on regular meetings between the compensation and risk
committees, while others rely on more ad hoc communications. Human
resources, risk management, finance, and audit committees work with
compensation committees to ensure that compensation systems attain
multiple objectives, including appropriate risk-taking.\223\
---------------------------------------------------------------------------

    \223\ See generally 2011 FRB White Paper; FSB, ``FSB 2015
Workshop on Compensation Practices'' (April 14, 2015), available at
http://www.fsb.org/wp-content/uploads/Summary-of-the-April-2015-FSB-workshop-on-compensation-practices.pdf.
---------------------------------------------------------------------------

    Section __.10(b)(2) of the proposed rule would require the
compensation committees to obtain from management, on an annual or more
frequent basis, a written assessment of the covered institution's
incentive-based compensation program and related compliance and control
processes. The

report should assess the extent to which the program and processes
provide risk-taking incentives that are consistent with the covered
institution's risk profile. Management would be required to develop the
assessment with input from the covered institutions' risk and audit
committees, or groups performing similar functions, and from
individuals in risk management and audit functions. In addition to the
written assessment submitted by management, section __.10(b)(3) of the
proposed rule would require the compensation committee to obtain
another written assessment on the same matter, submitted on an annual
or more frequent basis, by the internal audit or risk management
function of the covered institution. This written assessment would be
developed independently of the covered institution's management.
    The Agencies are proposing that the independent compensation
committee of the board of directors to be the recipient of such input
and written assessments.
    Developing incentive-based compensation arrangements that provide
balanced risk-taking incentives and monitoring arrangements to ensure
they achieve balance requires an understanding of the full spectrum of
risks (including compliance risks) and potential risk outcomes
associated with the activities of covered persons. For this reason,
risk-management and other control functions generally should each have
an appropriate role in the covered institution's processes, not only
for designing incentive-based compensation arrangements, but also for
assessing their effectiveness in providing risk-taking incentives that
are consistent with the risk profile of the institution. The proposed
rule sets forth two separate effectiveness assessments: (1) An
assessment under the auspices of management, but reliant on risk
management and audit functions, as well as the audit and risk
committees of the board, and (2) an assessment conducted by the
internal audit or risk management function of the covered institution,
independent of management.
    In support of the first requirement, a covered institution's
management has a full understanding of both the entirety of the covered
institution's activities and a detailed understanding of its incentive-
based compensation program, including both the performance that the
covered institution intends to reward and the risks to which covered
persons can expose the covered institution. An understanding of the
full compensation program (including the effectiveness of risk measures
across various lines of business, the measurement of actual risk
outcomes, and the analysis of risk-taking and risk outcomes relative to
incentive-based compensation payments) requires a large degree of
technical expertise. It also requires an understanding of the wider
strategic and risk management frameworks in place at the covered
institution (including the various objectives that compensation
programs seek to balance, such as recruiting and retention goals and
prudent risk management). While the board of directors at a covered
institution is ultimately responsible for the balance of incentive-
based compensation arrangements, and for an incentive-based
compensation program that incentivizes behaviors consistent with the
long-term health of the organization, the board should generally hold
senior management accountable for effectively executing the covered
institution's incentive-based compensation program, and for modifying
it when weaknesses are identified.
    In addition, some Level 1 and Level 2 covered institutions use
automated systems to monitor the effectiveness of incentive-based
compensation arrangements in balancing risk-taking incentives,
especially systems that support capture of relevant data in databases
that support monitoring and analysis. Management plays a role in all of
these activities and is well-positioned to oversee an analysis that
considers such a wide variety of inputs. In order to ensure that
considerations of risk-taking are included in such an exercise, an
active role for independent control functions is critical in such a
review as well as input from the risk and audit committees of the board
of directors, or groups performing similar functions. Periodic
presentations by the chief risk officer or other risk management staff
to the board of directors can help complement the annual effectiveness
review.
    In addition, the proposed rule includes a requirement that internal
audit or risk management submit a written assessment of the
effectiveness of a Level 1 or Level 2 covered institution's incentive-
based compensation program and related control processes in providing
risk-taking incentives that are consistent with the risk profile of the
covered institution. Regular internal reviews and audits of compliance
with policies and procedures are important to helping implement the
incentive-based compensation system as intended by those employees
involved in incentive-based compensation decision-making. Internal
audit and risk management are well-positioned to provide an independent
perspective on a covered institution's incentive-based compensation
program and related control processes. The Federal Banking Agencies
have observed that compensation committees benefit from an independent
analysis of the effectiveness of their covered institutions' incentive-
based compensation programs.\224\
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    \224\ For example, the 2010 Federal Banking Agency Guidance
notes that a banking organization's risk-management processes and
internal controls should reinforce and support the development and
maintenance of balanced incentive compensation arrangements.
---------------------------------------------------------------------------

    The proposed requirement takes into consideration comments received
on the policies and procedures standards embodied in the 2011 Proposed
Rule that would have required the covered financial institution's board
of directors, or a committee thereof, to receive data and analysis from
management and other sources sufficient to allow the board, or
committee thereof, to assess whether the overall design and performance
of the institution's incentive-based compensation arrangements were
consistent with section 956. Many commenters on the 2011 Proposed Rule
expressed concern that the proposed requirements in the 2011 Proposed
Rule would have inappropriately expanded the traditional ``oversight''
role of the board and would have required the board to exercise
judgment in areas that traditionally have been--and, in the view of
some commenters, are best left to--the expertise and prerogative of
management. Commenters suggested that the proposed requirement instead
place responsibility on management to conduct a formal assessment of
the effectiveness of the covered institution's incentive-based
compensation program and related compliance and control processes. The
Agencies agree that management should be responsible for conducting
such an assessment and section __.10(b)(2) of the proposed rule would
thus place this responsibility on management, while requiring input
from risk and audit committees, or groups performing similar functions,
and from the covered institutions' risk management and audit functions.
Under the proposed rule, the board's primary focus would be oversight
of incentive-based compensation program and arrangements, while
management would be expected to implement a program consistent with the
vision of the board.
    10.1. The Agencies invite comment on this provision generally and
whether the written assessments required under sections __.10(b)(2) and
__.10(b)(3)

of the proposed rule should be provided to the compensation committee
on an annual basis or at more or less frequent intervals?
    10.2. Are both reports required under Sec.  __.10(b)(2) and (3)
necessary to aid the compensation committee in carrying out its
responsibilities under the proposed rule? Would one or the other be
more helpful? Why or why not?

Sec.  __.11 Policies and Procedures Requirements for Level 1 and Level
2 Covered Institutions

    Section __.11 of the proposed rule would require Level 1 and Level
2 covered institutions to develop and implement certain minimum
policies and procedures relating to their incentive-based compensation
programs. Requiring covered institutions to develop and follow policies
and procedures related to incentive-based compensation would help both
covered institutions and regulators identify the incentive-based
compensation risks to which covered institutions are exposed, and how
these risks are managed so as not to incentivize inappropriate risk-
taking by covered persons that could lead to material financial loss to
the covered institution. The Agencies are not proposing to require
specific policies and procedures of Level 3 covered institutions
because these institutions are generally less complex and the impact to
the financial system by risks taken at these covered institutions is
not as significant as risks taken by covered persons at the larger,
more complex covered institutions. In addition, by not requiring
additional policies and procedures, Agencies intend to reduce burden on
smaller covered institutions. In contrast, the larger Level 1 and Level
2 covered institutions generally will have more complex organizations
that tend to conduct a wide range of business activities and therefore
will need robust policies and procedures as part of their compliance
programs.\225\ Therefore, under section __.11 of the proposed rule,
Level 3 covered institutions would not be subject to any specific
requirements in this area, while Level 1 and Level 2 covered
institutions would be required to develop and implement specific
policies and procedures for their incentive-based compensation
programs.
---------------------------------------------------------------------------

    \225\ See Federal Reserve SR Letter 08-08, ``Compliance Risk
Management Programs and Oversight at Large Banking Organizations
with Complex Compliance Profiles'' (October 16, 2008).
---------------------------------------------------------------------------

    Section __.11 of the proposed rule would identify certain areas
that the policies and procedures of Level 1 and Level 2 covered
institutions would, at a minimum, have to address. The list is not
exhaustive. Instead, it is meant to indicate the policies and
procedures that would, at a minimum, be necessary to carry out the
requirements in other sections of the proposed rule.
    The development and implementation of the policies and procedures
under section __.11 of the proposed rule would help to ensure and
monitor compliance with the requirements set forth in section 956 and
the other requirements in the proposed rule because the policies and
procedures would set clear expectations for covered persons and allow
the Agencies to better understand how a covered institution's
incentive-based compensation program operates. Section __.11(a) of the
proposed rule would contain the general requirement that the policies
and procedures be consistent with the prohibitions and requirements
under the proposed rule. Other parts of section __.11 of the proposed
rule would help to ensure and monitor compliance with specific portions
of the proposed rule.
    Under section __.11(b) of the proposed rule, a Level 1 or Level 2
covered institution would have to develop and implement policies and
procedures that specify the substantive and procedural criteria for the
application of forfeiture and clawback, including the process for
determining the amount of incentive-based compensation to be clawed
back. These policies and procedures would provide covered persons with
notice of the circumstances that would lead to forfeiture and clawback
at their covered institutions, including any circumstances identified
by the covered institution in addition to those required under the
proposed rule. They would also help ensure consistent application of
forfeiture and clawback by establishing a common set of expectations.
    Policies and procedures should make clear the triggers that will
result in consideration of forfeiture, downward adjustment, and
clawback; should indicate what individuals or committees are
responsible for identifying, escalating and resolving these issues in
such cases; should ensure that control functions contribute relevant
information and participate in any decisions; and should set out a
clear process for determining responsibility for the events triggering
the forfeiture and downward adjustment review including provisions
requiring appropriate input from covered employees under consideration
for forfeiture or clawback.
    The proposed rule also would require that Level 1 and Level 2
covered institutions' policies and procedures require the maintenance
of documentation of final forfeiture, downward adjustment, and clawback
decisions under section __.11(c) of the proposed rule. Documentation
would allow control functions and the Agencies to evaluate compliance
with the requirements of section __.7 of the proposed rule. The
Agencies are proposing this requirement because they have found that it
is critical that forfeiture and downward adjustment reviews at covered
institutions be supported by effective governance to ensure
consistency, fairness and robustness of all related decision-making.
    Section __.11(d) of the proposed rule would include a requirement
for policies and procedures of Level 1 and Level 2 covered institutions
that would specify the substantive and procedural criteria for
acceleration of payments of deferred incentive-based compensation to a
covered person consistent with sections __.7(a)(1)(iii)(B) and
__.7(a)(2)(iii)(B) of the proposed rule. Under section __.7 of the
proposed rule, acceleration of vesting of incentive-based compensation
that is required to be deferred under such section would only be
permitted in the case of death or disability. A Level 1 or Level 2
covered institution would have to have policies and procedures that
describe how disability would be evaluated for purposes of determining
whether to accelerate payments of deferred incentive-based
compensation.
    Section __.11(e) would require Level 1 and Level 2 covered
institutions to have policies and procedures that identify and describe
the role of any employees, committees, or groups authorized to make
incentive-based compensation decisions, including when discretion is
authorized. A Level 1 or Level 2 covered institution's policies and
procedures would also have to describe how discretion is expected to be
exercised in order to appropriately balance risk and reward and how the
incentive-based compensation arrangements will be monitored under
sections __.11(f) and (h) of the proposed rule, respectively.
    Related to the requirements regarding disclosure under sections
__.4(f) and __.5 of the proposed rule, under section __.11(g), a Level
1 or Level 2 covered institution would need to have policies and
procedures that require the covered institution to maintain
documentation of the establishment, implementation, modification, and
monitoring of incentive-based

compensation arrangements sufficient to support the covered
institution's decisions. Section __.11(i) would require the policies
and procedures to specify the substantive and procedural requirements
of the independent compliance program, consistent with section
__.9(a)(2). And section __.11(j) would require policies and procedures
that address the appropriate roles for risk management, risk oversight,
and other control function personnel in the covered institution's
processes for (1) designing incentive-based compensation arrangements
and determining awards, deferral amounts, deferral periods, forfeiture,
downward adjustment, clawback, and vesting, and (2) assessing the
effectiveness of incentive-based compensation arrangements in
restraining inappropriate risk-taking.
    The Agencies anticipate that some Level 1 and Level 2 covered
institutions that have international operations might choose to adopt
enterprise-wide incentive-based compensation policies and procedures.
The Agencies recognize that such policies and procedures, when utilized
by various subsidiary institutions, may need to be further modified to
reflect local regulation and the requirements of home country
regulators in the case of international institutions and tailored to a
certain extent by line of business, legal entity, or business model.
    11.1. The Agencies invite general comment on the proposed policies
and procedures requirements for Level 1 and Level 2 covered
institutions under section __.11 of the proposed rule.

Sec.  __.12 Indirect Actions

    Section __.12 of the proposed rule would prohibit a covered
institution from doing indirectly what it cannot do directly under the
proposed rule. Section __.12 would apply all of the proposed rule's
requirements and prohibitions to actions taken by covered institutions
indirectly or through or by any other person. Section __.12 is
substantially the same as section __.7 of the 2011 Proposed Rule. The
Agencies did not receive any comments on section __.7 of the 2011
Proposed Rule.
    By subjecting such indirect actions by covered institutions to all
of the proposed rule's requirements and prohibitions, section __.12
would implement the directive in section 956(b) to adopt rules that
prohibit any type of incentive-based payment arrangement, or any
feature of any such arrangement, that the Agencies determine encourages
inappropriate risks by covered institutions (1) by providing excessive
compensation, fees, or benefits or (2) that could lead to material
financial loss. The Agencies are concerned that a covered institution
may take indirect actions in order to avoid application of the proposed
rule's requirements and prohibitions. For example, a covered
institution could attempt to make substantial numbers of its covered
persons independent contractors for the purpose of avoiding application
of the proposed rule's requirements and prohibitions. A covered
institution could also attempt to make substantial numbers of its
covered persons employees of another entity for the purpose of avoiding
application of the proposed rule's requirements and prohibitions. If
left unchecked, such indirect actions could encourage inappropriate
risk-taking by providing covered persons with excessive compensation or
could lead to material financial loss at a covered institution.
    The Agencies, however, do not intend to disrupt indirect actions,
including independent contractor or employment relationships, not
undertaken for the purpose of avoiding application of the proposed
rule's requirements and prohibitions. Thus, the Agencies would apply
the proposed rule regardless of how covered institutions classify their
actions, while also recognizing that covered institutions may
legitimately engage in activities that are outside the scope of section
956 and the proposed rule.\226\
---------------------------------------------------------------------------

    \226\ The Agencies note, however, that section 956 of the Dodd-
Frank Act does not, and the proposed rule would not, limit the
authority of the Agencies under other provisions of applicable law
and regulations.
---------------------------------------------------------------------------

    NCUA's proposed rule also would clarify that covered credit unions
may not use CUSOs to avoid the requirements of the proposed rule, such
as by using CUSOs to maintain non-compliant incentive-based
compensation arrangements on behalf of senior executive officers or
significant risk-takers of Federally insured credit unions.
    12.1. Commenters are invited to address all aspects of section
__.12, including any examples of other indirect actions that the
Agencies should consider.

Sec.  __.13 Enforcement

    By its terms, section 956 applies to any depository institution and
any depository institution holding company (as those terms are defined
in section 3 of the FDIA), any broker-dealer registered under section
15 of the Securities Exchange Act, any credit union, any investment
adviser (as that term is defined in the Investment Advisers Act of
1940), the Federal National Mortgage Association, and the Federal Home
Loan Mortgage Corporation. Section 956 also applies to any other
financial institution that the appropriate Federal regulators jointly
by rule determine should be treated as a covered financial institution
for purposes of section 956.
    Section 956(d) also specifically sets forth the enforcement
mechanism for rules adopted under that section. The statute provides
that section 956 and the implementing rules shall be enforced under
section 505 of the Gramm-Leach-Bliley Act and that a violation of
section 956 or the regulations under section 956 will be treated as a
violation of subtitle A of Title V of the Gramm-Leach-Bliley Act.
    Section 505 of the Gramm-Leach-Bliley Act provides for enforcement
under section 1818 of title 12, by the appropriate Federal banking
agency, as defined in section 1813(q) of title 12,\227\ in the case of
national banks, Federal branches and Federal agencies of foreign banks,
and any subsidiaries of such entities (except brokers, dealers, persons
providing insurance, investment companies, and investment advisers);
member banks of the Federal Reserve System (other than national banks),
branches and agencies of foreign banks (other than Federal branches,
Federal agencies, and insured State branches of foreign banks),
commercial lending companies owned or controlled by foreign banks,
organizations operating under section 25 or 25A of the Federal Reserve
Act [12 U.S.C. 601 et seq., 611 et seq.], and bank holding companies
and their nonbank subsidiaries or affiliates (except brokers, dealers,
persons providing insurance, investment companies, and investment
advisers); as well as banks insured by the FDIC (other than members of
the Federal Reserve System), insured State branches of foreign banks,
and any subsidiaries of such entities (except brokers, dealers, persons
providing insurance, investment companies, and investment advisers);
and savings associations the deposits of which are insured by the FDIC,
and any subsidiaries of such savings associations (except brokers,
dealers, persons providing insurance, investment companies, and
investment advisers).
---------------------------------------------------------------------------

    \227\ For purposes of section 1813(q), the appropriate Federal
banking agency for institutions listed in paragraphs (A) and (D) is
the OCC; for institutions listed in paragraphs (B), the Board; and
for institutions listed in paragraph (C), the FDIC. 12 U.S.C.
1813(q).
---------------------------------------------------------------------------

    The Gramm-Leach-Bliley Act also provides for enforcement under the
following: (1) Federal Credit Union Act

[12 U.S.C. 1751 et seq.], by the Board of the NCUA with respect to any
federally insured credit union, and any subsidiaries of such an entity;
(2) the Securities Exchange Act of 1934 [15 U.S.C. 78a et seq.], by the
SEC with respect to any broker or dealer; (3) the Investment Company
Act of 1940 [15 U.S.C. 80a-1 et seq.], by the SEC with respect to
investment companies; (4) the Investment Advisers Act of 1940 [15
U.S.C. 80b-1 et seq.], by the SEC with respect to investment advisers
registered with the Commission under such Act; (5) State insurance law,
in the case of any person engaged in providing insurance, by the
applicable State insurance authority of the State in which the person
is domiciled, subject to section 6701 of the Gramm-Leach-Bliley Act;
(6) the Federal Trade Commission Act [15 U.S.C. 41 et seq.], by the
Federal Trade Commission for any other financial institution or other
person that is not subject to the jurisdiction of any agency or
authority listed above; and (7) subtitle E of the Consumer Financial
Protection Act of 2010 [12 U.S.C. 5561 et seq.], by the Bureau of
Consumer Financial Protection, in the case of any financial institution
and other covered person or service provider that is subject to the
jurisdiction of the Bureau.
    The proposed rule includes these enforcement provisions as provided
in section 956.
    FHFA's enforcement authority for the proposed rule derives from its
authorizing statute, the Safety and Soundness Act. FHFA is not one of
the ``Federal functional regulators'' listed in section 505 of the
Gramm-Leach-Bliley Act. Additionally, the applicability of Title V of
the Gramm-Leach-Bliley Act to Fannie Mae and Freddie Mac is limited by
their conditional exclusion from that Title's definition of ``financial
institution.'' But there is no evidence that Congress intended to
exclude FHFA, or Fannie Mae and Freddie Mac, from enforcement of the
proposed rule. To the contrary, Congress specifically included Fannie
Mae and Freddie Mac as covered financial institutions and FHFA as an
``appropriate federal regulator'' in section 956, and FHFA requires no
additional enforcement authority. The Safety and Soundness Act provides
FHFA with enforcement authority for all laws and regulations that apply
to its regulated entities.
    13.1. The Agencies invite comment on all aspects of section __.13.

Sec.  __.14 NCUA and FHFA Covered Institutions in Conservatorship,
Receivership, or Liquidation

    The NCUA's and FHFA's proposed rules each include a section __.14
that would address those instances when a covered institution is placed
in conservatorship, receivership, or liquidation, including limited-
life regulated entities, under their respective authorizing statutes,
the Federal Credit Union Act or the Safety and Soundness Act.\228\ If a
covered institution is placed in conservatorship, receivership, or
liquidation, the conservator, receiver, or liquidating agent,
respectively, and not the covered institution's board or management,
has ultimate authority over all compensation arrangements, including
any incentive-based compensation for covered persons. When determining
or approving any incentive-based compensation plans for covered persons
at such a covered institution, the conservator, receiver, or
liquidating agent will implement the purposes of the Dodd-Frank Act by
prohibiting excessive incentive-based compensation and incentive-based
compensation that encourages inappropriate risk-taking.
---------------------------------------------------------------------------

    \228\ The FDIC's proposed rule would not apply to institutions
for which the FDIC is appointed receiver under the FDIA or Title II
of the Dodd-Frank Act, as appropriate, as those statutes govern such
cases.
---------------------------------------------------------------------------

    Institutions placed in conservatorship, receivership, or
liquidation may be subject to different needs and circumstances with
respect to attracting and retaining talent than other types of covered
institutions. In order to attract and retain qualified individuals at a
covered institution in conservatorship, for example, the conservator
may determine that while a significant portion of a covered person's
incentive-based compensation should be deferred, due to the uncertain
future of the covered institution in conservatorship, the deferral
period would be shorter than that set forth in the deferral provisions
of the proposed rule. In another example, where a conservator assumes
the roles and responsibilities of the covered institution's board and
its committees, the conservator may determine that it is not necessary
for the board of the covered institution, if any remains in
conservatorship, to approve a material adjustment to a senior executive
officer's incentive-based compensation arrangement as described by the
governance section of the proposed rule.
    Certain provisions of the proposed rule, such as the deferral and
governance provisions, may not be appropriate for institutions in
conservatorship, receivership, or liquidation, and the incentive-based
compensation structure that best meets their needs while implementing
the purposes of the Dodd-Frank Act is appropriately left to the
conservator, receiver, or liquidating agent, respectively. Under the
applicable section __.14 of the proposed rule, if a covered institution
is placed in conservatorship, receivership, or liquidation under the
Safety and Soundness Act, for FHFA's proposed rule, or the Federal
Credit Union Act, for the NCUA's proposed rule, the respective
conservator, receiver, or liquidating agent would have the
responsibility to fulfill the requirements and purposes of 12 U.S.C.
5641. The conservator, receiver, or liquidating agent also has the
discretion to determine transition terms should the covered institution
cease to be in conservatorship, receivership, or liquidation.
    14.1. Commenters are invited to address all aspects of section
__.14 of the proposed rule.

SEC Amendment to Exchange Act Rule 17a-4

    The SEC is proposing an amendment to Exchange Act Rule 17a-4(e) (17
CFR 240.17a-4(e)) to require that broker-dealers maintain the records
required by Sec.  __.4(f), and for Level 1 and Level 2 broker-dealers,
Sec. Sec.  __.5 and __.11, in accordance with the recordkeeping
requirements of Exchange Act Rule 17a-4. Exchange Rule 17a-4
establishes the general formatting and storage requirements for records
that broker-dealers are required to keep. For the sake of consistency
with other broker-dealer records, the SEC believes that broker-dealers
should also keep the records required by Sec.  __.4(f), and for Level 1
and Level 2 broker-dealers, Sec. Sec.  __.5 and __.11, in accordance
with these requirements.
    New paragraph (e)(10) of Exchange Act Rule 17a-4 would require
Level 1, Level 2, and Level 3 broker-dealers to maintain and preserve
in an easily accessible place the records required by Sec.  __.4(f),
and for Level 1 and Level 2 broker-dealers, the records required by
Sec. Sec.  __.5 and __.11. Paragraph (f) of Exchange Act Rule 17a-4
provides that the records a broker-dealer is required to maintain and
preserve under Exchange Act Rule 17a-3 (17 CFR 240.17a-3) and Exchange
Act Rule 17a-4 may be immediately produced or reproduced on
micrographic media or by means of electronic storage media. Paragraph
(j) of Exchange Act Rule 17a-4 requires a broker-dealer, which would
include a

broker-dealer that is a Level 1, Level 2, or Level 3 covered
institution pursuant to the proposed rules, to furnish promptly to a
representative of the SEC legible, true, complete, and current copies
of those records of the broker-dealer that are required to be preserved
under Exchange Act Rule 17a-4, or any other records of the broker-
dealer subject to examination under section 17(b) of the Securities
Exchange Act of 1934 that are requested by the representative.\229\
---------------------------------------------------------------------------

    \229\ For a discussion generally of Exchange Act Rule 17a-4, see
Recordkeeping and Reporting Requirements for Security-Based Swap
Dealers, Major Security-Based Swap Participants, and Broker-Dealers;
Capital Rule for Certain Security-Based Swap Dealers, Release No.
34-71958 (Apr. 17, 2014), 79 FR 25194 (May 2, 2014).
---------------------------------------------------------------------------

SEC Amendment to Investment Advisers Act Rule 204-2

    The SEC is proposing an amendment to rule 204-2 under the
Investment Advisers Act (17 CFR 275.204-2) to require that investment
advisers registered or required to be registered under section 203 of
the Investment Advisers Act (15 U.S.C. 80b-3) maintain the records
required by Sec.  __.4(f) and, for those investment advisers that are
Level 1 or Level 2 covered institutions, Sec. Sec.  __.5 and __.11, in
accordance with the recordkeeping requirements of rule 204-2. New
paragraph (a)(19) of rule 204-2 would require investment advisers
subject to rule 204-2 that are Level 1, Level 2, or Level 3 covered
institutions to make and keep true, accurate, and current the records
required by, and for the period specified in, Sec.  __.4(f) and, for
those investment advisers that are Level 1 or Level 2 covered
institutions, the records required by, and for the periods specified
in, Sec. Sec.  __.5 and __.11.
    Rule 204-2 establishes the general recordkeeping requirements for
investment advisers registered or required to be registered under
section 203 of the Investment Advisers Act. For the sake of consistency
with other investment adviser records, the SEC is proposing that this
rule require such investment advisers that are covered institutions to
keep the records required by Sec.  __.4(f) and those that are Level 1
or Level 2 covered institutions to keep the records required by
Sec. Sec.  __.5 and __.11 in accordance with the requirements of rule
204-2.

III. Appendix to the Supplementary Information: Example Incentive-Based
Compensation Arrangement and Forfeiture and Downward Adjustment Review

    For an incentive-based compensation arrangement to meet the
requirements of the proposed rule, particularly the requirement that
such an arrangement appropriately balance risk and reward, covered
institutions would need to look holistically at the entire incentive-
based arrangement. Below, for purposes of illustration only, the
Agencies outline an example of a hypothetical incentive-based
compensation arrangement that would meet the requirements of the
proposed rule and an example of how a forfeiture and downward
adjustment review might be conducted. These illustrations do not cover
every aspect of the proposed rule. They are provided as an aid to
understanding the proposed rule and would not carry the force and
effect of law or regulation, if issued as a companion to a final rule.
Reviewing these illustrations does not substitute for a review of the
proposed rule.
    This example assumes that the final rule was published as proposed
and all incentive-based compensation programs and arrangements were
required to comply on or before January 1, 2020.

Ms. Ledger: Senior Executive Officer at Level 2 Covered Institution

    Ms. Ledger is the chief financial officer at a bank holding
company, henceforth ``ABC,'' which has $200 billion in average total
consolidated assets. Under the definitions of the proposed rule Ms.
Ledger would be a senior executive officer and ABC would be a Level 2
covered institution.\230\
---------------------------------------------------------------------------

    \230\ See the definitions of ``senior executive officer'' and
``Level 2 covered institution'' in section __.2 of the proposed
rule.
---------------------------------------------------------------------------

    Ms. Ledger is provided incentive-based compensation under three
separate incentive-based compensation plans. The first plan, the
``Annual Executive Plan,'' is applicable to all senior executive
officers at ABC, and requires assessment over the course of one
calendar year. The second plan, the ``Annual Firm-Wide Plan,'' is
applicable to all employees at ABC, and is also based on a one-year
performance period that coincides with the calendar year. The third
plan, ``Ms. Ledger's LTIP,'' is applicable only to Ms. Ledger, and
requires assessment of performance over a three-year performance period
that begins on January 1 of year 1 and ends on December 31 of year 3.
These three plans together comprise Ms. Ledger's incentive-based
compensation arrangement.
    The proposed rule would impose certain requirements on Ms. Ledger's
incentive-based compensation arrangement. Section __.4(a)(1) of the
proposed rule would require that Ms. Ledger's entire incentive-based
compensation arrangement, and each feature of that arrangement, not
provide excessive compensation. ABC would be required to consider the
six factors listed in section __.4(b) of the proposed rule, as well as
any other factors that ABC finds relevant, in evaluating whether Ms.
Ledger's incentive-based compensation arrangement provides excessive
compensation before approving Ms. Ledger's incentive-based compensation
arrangement.

Balance

    Under section __.4(c)(1) of the proposed rule, the entire
arrangement would be required to appropriately balance risk and reward.
ABC would be expected to consider the risks that Ms. Ledger's
activities pose to the institution, and the performance that Ms.
Ledger's incentive-based compensation arrangement rewards. ABC might
consider both the type and target level of any associated performance
measures; how all performance measures would work together under the
three plans; the form of incentive-based compensation; the recourse ABC
has to reduce incentive-based compensation once awarded (through
forfeiture) \231\ including under the conditions outlined in section
__.7 of the proposed rule; the ability ABC has to use clawback of
incentive-based compensation once vested, including under the
conditions outlined in section __.7 of the proposed rule; and any
overlapping performance periods of the various incentive-based
compensation plans, which apply to Ms. Ledger.
---------------------------------------------------------------------------

    \231\ This requirement for balance under section __.4(c)(1)
would not, however require forfeiture, or any specific forfeiture
measure, for any particular covered person. As discussed below,
sections __.7 and __.8 contain specific requirements applicable to
senior executive officers at Level 1 and Level 2 covered
institutions.
---------------------------------------------------------------------------

    Under section __.4(d) of the proposed rule, Ms. Ledger's incentive-
based compensation arrangement would be required to include both
financial and non-financial measures of performance. These measures
would need to include considerations of risk-taking that are relevant
to Ms. Ledger's role within ABC and to the type of business in which
Ms. Ledger is engaged. They also would need to be appropriately
weighted to reflect risk-taking. The arrangement would be required to
allow non-financial

measures of performance to override financial measures of performance
when appropriate in determining Ms. Ledger's incentive-based
compensation. Any amounts to be awarded under Ms. Ledger's arrangement
would be subject to adjustment to reflect ABC's actual losses,
inappropriate risks Ms. Ledger took or was accountable for others
taking, compliance deficiencies Ms. Ledger was accountable for, or
other measures or aspects of Ms. Ledger's and ABC's financial and non-
financial performance. For example, the Annual Firm-Wide Plan might use
a forward-looking internal profit measure that takes into account
stressed conditions as a proxy for liquidity risk that Ms. Ledger's
activities pose to ABC and thus mitigates against incentives to take
imprudent liquidity risk. It might also include limits on liquidity
risk, the repeated breach of which would result in non-compliance with
a key non-financial performance objective.
    In practice, each incentive-based compensation plan will include
various measures of performance, and under the proposed rule, each plan
would be required to include both financial and non-financial measures.
The Annual Firm-Wide Plan may be largely based on the change in value
of ABC's equity over the performance year, but that cannot be the only
basis for incentive-based compensation awarded under that plan. Non-
financial measures of Ms. Ledger's risk-taking activity would have to
be taken into account in determining the incentive-based compensation
awarded under that plan, and those non-financial measures would need to
be appropriately weighted so that they could override financial
measures. Even if ABC's equity performed very well over the performance
year, if Ms. Ledger was found to have violated risk performance
measures, Ms. Ledger should not be awarded the full target of
incentive-based compensation from the plan.
    Because Ms. Ledger is a senior executive officer at a Level 2
covered institution, Ms. Ledger's incentive-based compensation
arrangement would not be considered to appropriately balance risk and
reward unless it was structured to be consistent with the requirements
set forth in sections __.7 and __.8 of the proposed rule. The
incentive-based compensation awarded to Ms. Ledger would not be
permitted to be based solely on relative performance measures \232\ or
be based solely on transaction revenue or volume.\233\ The Annual
Executive Plan may include a measure of ABC's TSR relative to its peer
group, but that plan would comply with the proposed rule only if other
absolute measures of ABC's or Ms. Ledger's performance were also
included (e.g., achievement of a three-year average return on risk
adjusted capital). Similarly, a plan that applied to significant risk-
takers who were engaged in trading might include transaction volume as
one of the financial performance measures, but that plan would comply
with the proposed rule only if it also included other factors, such as
measurement of transaction quality or the significant risk-taker's
compliance with the institution's risk-management policies.
---------------------------------------------------------------------------

    \232\ See section __.8(c) of the proposed rule.
    \233\ See section __.8(d) of the proposed rule.
---------------------------------------------------------------------------

Award of Incentive-Based Compensation for Performance Periods Ending
December 31, 2024

    Ms. Ledger's incentive-based compensation is awarded on January 31,
2025. The Annual Executive Plan and the Annual Firm-Wide Plan are
awarded on this date for the performance period starting on January 1,
2024 and ending on December 31, 2024. Ms. Ledger's LTIP will be awarded
on this date for the performance period starting on January 1, 2022 and
ending on December 31, 2024. This example assumes ABC's share price on
December 31, 2024 (the end of the performance period) is $50.
    Ms. Ledger's target incentive-based compensation award amount under
the Annual Executive plan is $60,000 and 1,000 shares of ABC.\234\
Under the Annual Firm-Wide Plan, Ms. Ledger's target incentive-based
compensation award amount is $30,000. Finally, under Ms. Ledger's LTIP,
her target incentive-based compensation award amount is $40,000 and
2,000 shares of ABC.
---------------------------------------------------------------------------

    \234\ That is, if Ms. Ledger meets all of the performance
measure targets set out under that plan, she will be awarded both
$60,000 in cash and 1,000 shares of ABC stock.
---------------------------------------------------------------------------

    To be consistent with the proposed rule, the maximum incentive-
based compensation amounts that ABC would be allowed to award to Ms.
Ledger are 125 percent of the target amount, which would amount to:
$75,000 and 1,250 shares under the Annual Executive Plan; $37,500 under
the Annual Firm-Wide Plan; and $50,000 and 2,500 shares under Ms.
Ledger's LTIP.
    If Ms. Ledger were implicated in a forfeiture and downward
adjustment review during the performance period, ABC would be expected
to consider whether and by what amount to reduce the amounts awarded to
Ms. Ledger. As part of that review, ABC would be expected to consider
all of the amounts that could be awarded to Ms. Ledger under the Annual
Executive Plan, Annual Firm-Wide Plan, and Ms. Ledger's LTIP for
downward adjustment before any incentive-based compensation were
awarded to Ms. Ledger.\235\
---------------------------------------------------------------------------

    \235\ See section __.7(b) of the proposed rule.
---------------------------------------------------------------------------

    Regardless of whether a downward forfeiture and downward adjustment
review occurred, ABC would be expected to evaluate Ms. Ledger's
performance, including Ms. Ledger's risk-taking activities, at or near
the end of the performance period (December 31, 2024). ABC would be
required to use non-financial measures of performance, and particularly
measures of risk-taking, to determine Ms. Ledger's incentive-based
compensation award, possibly decreasing the amount Ms. Ledger would be
awarded if only financial measures were taken into account.\236\
---------------------------------------------------------------------------

    \236\ See section __.4(d)(2) of the proposed rule.
---------------------------------------------------------------------------

    Based on performance and taking into account Ms. Ledger's risk-
taking behavior, ABC decides to award Ms. Ledger: $30,000 and 1,000
shares under the Annual Executive Plan; $35,000 under the Annual Firm-
Wide Plan; and $40,000 and 2,000 shares under Ms. Ledger's LTIP.
Valuing the ABC equity at the time of award, the total value of Ms.
Ledger's award under the Annual Executive Plan is $80,000, under the
Annual Firm-Wide Plan is $35,000, and under Ms. Ledger's LTIP is
$140,000.

------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                             Target award                                Maximum award                               Actual award
                                                             -----------------------------------------------------------------------------------------------------------------------------------
                Incentive-based compensation                                         Value of    Total                           Value of    Total                           Value of    Total
                                                              Cash  ($)    Equity     equity     value    Cash  ($)    Equity     equity     value     Cash \1\    Equity     equity     value
                                                                            (#)        ($)        ($)                   (#)        ($)        ($)        ($)      \2\  (#)     ($)        ($)
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Annual Executive Plan.......................................     60,000      1,000     50,000    110,000     75,000      1,250     62,500    137,500     30,000      1,000     50,000     80,000
Annual Firm-Wide Plan.......................................     30,000  .........  .........     30,000     37,500  .........  .........     37,500     35,000  .........  .........     35,000
Ms. Ledger's LTIP...........................................     40,000      2,000    100,000    140,000     50,000      2,500    125,000    175,000     40,000      2,000    100,000    140,000
                                                             -----------------------------------------------------------------------------------------------------------------------------------

    Total Incentive-Based Compensation......................    130,000      3,000    150,000    280,000    162,500      3,750     87,500    350,000    105,000      3,000    150,000    255,000
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
\1\ The amount of actual cash award ABC chose to award.
\2\ The amount of actual equity award ABC chose to award.

    To calculate the minimum required deferred amounts, ABC would have
to aggregate the amounts awarded under both the Annual Executive Plan
($80,000) and the Annual Firm-Wide Plan ($35,000), because each has the
same performance period, which is less than three years, to determine
the total amount of qualifying incentive-based compensation awarded
($115,000).\237\ At least 50 percent of that qualifying incentive-based
compensation would be required to be deferred for at least three
years.\238\ Thus, ABC would be required to defer cash and equity with
an aggregate value of at least $57,500 from qualifying incentive-based
compensation. ABC would have the flexibility to defer the amounts
awarded in cash or in equity, as long as the total deferred incentive-
based compensation was composed of both substantial amounts of deferred
cash and substantial amounts of deferred equity.\239\ ABC would also
have the flexibility to defer amounts awarded from either the Annual
Executive Plan or the Annual Firm-Wide Plan.
---------------------------------------------------------------------------

    \237\ See section __.7(a)(1) of the proposed rule.
    \238\ See sections __.7(a)(1)(i)(C) and __.7(a)(1)(ii)(B) of the
proposed rule.
    \239\ See section __.7(a)(4)(i) of the proposed rule.
---------------------------------------------------------------------------

    In this example, ABC chooses to defer $27,500 of cash and 650
shares from Ms. Ledger's award from the Annual Executive Plan, which
has a total value of $60,000 at the time of the award, for three years
and none of the award under the Annual Firm-Wide Plan.\240\
---------------------------------------------------------------------------

    \240\ Ms. Ledger's entire award under the Annual Firm-Wide Plan,
$35,000, and remaining award under the Annual Executive Plan, $2,500
and 350 shares, could vest immediately.

--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                 Total award                    Minimum required deferred                   Actual deferred
                                ------------------------------------------------------------------------------------------------------------------------
  Incentive-based compensation                          Value of    Total      Total                 Total                           Value of    Total
                                 Cash  ($)    Equity     equity     value      value     Deferral    value     Cash \2\    Equity     equity     value
                                               (#)        ($)        ($)        ($)     rate  (%)     ($)        ($)      \3\  (#)     ($)        ($)
--------------------------------------------------------------------------------------------------------------------------------------------------------
Annual Executive Plan..........     30,000      1,000     50,000     80,000  .........  .........  .........     27,500        650     32,500     60,000
Annual Firm-Wide Plan..........     35,000  .........  .........     35,000  .........  .........  .........  .........  .........  .........  .........
Qualified Incentive-Based           65,000      1,000     50,000    115,000    115,000         50     57,500     27,500        650     32,500     60,000
 Compensation..................
Ms. Ledger's LTIP..............     40,000      2,000    100,000    140,000    140,000         50     70,000     35,000        700     35,000     70,000
                                ------------------------------------------------------------------------------------------------------------------------
    Total Incentive-Based          105,000      3,000    150,000    255,000    255,000         50    127,500     62,500      1,350     67,500    130,000
     Compensation..............
--------------------------------------------------------------------------------------------------------------------------------------------------------
\1\ The aggregate amount from both the Annual Executive Plan and Annual Firm-Wide Plan.
\2\ The amount of actual cash award ABC chose to defer.
\3\ The amount of actual equity award ABC chose to defer.

Vesting Schedule

    ABC would have the flexibility to determine the schedule by which
this deferred incentive-based compensation would be eligible for
vesting, as long as the cumulative total of the deferred incentive-
based compensation that has been made eligible for vesting by any given
year is not greater than the cumulative total that would have been
eligible for vesting had the covered institution made equal amounts
eligible for vesting each year.\241\ With deferred qualifying
incentive-based compensation valued at $60,000 and three-year vesting,
no more than $20,000 would be allowed to be eligible to vest on
December 31, 2025, and no more than $40,000 would be eligible to vest
on or before December 31, 2026. At least $20,000 would need to be
eligible to vest on December 31, 2027, to be consistent with the
proposed rule. In this example, ABC decides to make none of the
deferred award from the Annual Executive Plan eligible for vesting on
December 31, 2025; to make $13,750 and 325 shares (total value of cash
and equity $30,000) eligible for vesting on December 31, 2026; and to
make $13,750 and 325 shares (total value of cash and equity $30,000)
eligible for vesting on December 31, 2027.
---------------------------------------------------------------------------

    \241\ See section __.7(a)(1)(iii) of the proposed rule.
---------------------------------------------------------------------------

    Ms. Ledger's LTIP has a performance period of three years, so Ms.
Ledger's LTIP would meet the definition of a ``long-term incentive-
plan'' under the proposed rule.\242\ At least 50 percent of Ms.
Ledger's LTIP amount ($140,000) would be required to be deferred for at
least one year.\243\ Thus, ABC would be required to defer cash and
equity with an aggregate value of at least $70,000 from Ms. Ledger's
LTIP, which would be eligible for vesting on December 31, 2025. ABC
would have flexibility to defer the amounts awarded in cash or in
equity, as long as the total deferred incentive-based compensation were
composed of both substantial amounts of deferred cash and substantial
amounts of deferred equity.\244\ If ABC chooses to defer amounts
awarded from Ms. Ledger's LTIP for longer than one year, ABC would have
flexibility to determine the schedule on which it would be eligible for
vesting, as long as the cumulative total of the deferred incentive-
based compensation that has been made eligible for vesting by any given
year is not greater than the cumulative total that would have been
eligible for vesting had the covered institution made equal amounts
eligible for vesting in one year.\245\
---------------------------------------------------------------------------

    \242\ See the definition of ``long-term incentive plan'' in
section __.2 of the proposed rule.
    \243\ See sections __.7(a)(2)(i)(C) and __.7(a)(2)(ii)(B) of the
proposed rule.
    \244\ See section __.7(a)(4)(i) of the proposed rule.
    \245\ See section __.7(a)(2)(iii) of the proposed rule.
---------------------------------------------------------------------------

    In this example, ABC chooses to defer $35,000 of cash and 700
shares of the award from Ms. Ledger's LTIP, which has a total value of
$70,000 at the time of the award, for one year.\246\ The non-deferred
amount ($35,000 and 700 shares) could vest at the time of the award on
January 31, 2025.
---------------------------------------------------------------------------

    \246\ Ms. Ledger's remaining award under Ms. Ledger's LTIP would
vest immediately.
---------------------------------------------------------------------------

    In summary, Ms. Ledger would receive $42,500 and 1,650 shares (a
total value of $125,000) immediately after December 31, 2024.\247\ A
total of $35,000 and 700 shares (total value $70,000) would be eligible
to vest on

December 31, 2025. A total of $13,750 and 325 shares (total value
$30,000) would be eligible to vest on December 31, 2026. Finally, a
total of $13,750 and 325 shares (total value $30,000) would again be
eligible to vest on December 31, 2027.
---------------------------------------------------------------------------

    \247\ This amount would represent $2,500 and 350 shares awarded
under the Annual Executive Plan, $35,000 awarded under the Annual
Firm-Wide Plan and $5,000 and 1,300 shares awarded under Ms.
Ledger's LTIP.

--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                               Immediate amounts payable                            Total amounts deferred
                                                 -------------------------------------------------------------------------------------------------------
          Incentive-based compensation                                        Value of   Total value                              Value of   Total value
                                                    Cash ($)    Equity (#)   equity ($)      ($)        Cash ($)    Equity (#)   equity ($)      ($)
--------------------------------------------------------------------------------------------------------------------------------------------------------
Annual Executive Plan...........................       $2,500          350      $17,500      $20,000      $27,500          650      $32,500      $60,000
Annual Firm-Wide Plan...........................       35,000  ...........  ...........       35,000  ...........  ...........  ...........  ...........
Ms. Ledger's LTIP...............................        5,000        1,300       65,000       70,000       35,000          700       35,000       70,000
                                                 -------------------------------------------------------------------------------------------------------
    Total Incentive-Based Compensation..........       42,500        1,650       82,500      125,000       62,500        1,350       67,500      130,000
--------------------------------------------------------------------------------------------------------------------------------------------------------

                                                                                Vesting Schedule
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                              12/31/2025                                  12/31/2026                                  12/31/2027
                                                             -----------------------------------------------------------------------------------------------------------------------------------
                Incentive-based compensation                                         Value of                                    Value of                                    Value of
                                                               Cash ($)    Equity     equity     Total     Cash ($)    Equity     equity     Total     Cash ($)    Equity     equity     Total
                                                                            (#)        ($)     value ($)                (#)        ($)     value ($)                (#)        ($)     value ($)
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Annual Executive Plan.......................................  .........  .........  .........  .........    $13,750        325    $16,250    $30,000    $13,750        325    $16,250    $30,000
Ms. Ledger's LTIP...........................................    $35,000        700    $35,000    $70,000  .........  .........  .........  .........  .........  .........  .........  .........
Amount Eligible for Vesting.................................  .........  .........  .........     70,000  .........  .........  .........     30,000  .........  .........  .........     30,000
Remaining Unvested Amount...................................  .........  .........  .........     60,000  .........  .........  .........     30,000  .........  .........  .........          0
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Use of Options in Deferred Incentive-Based Compensation

    If, under the total award amount outlined above, ABC chooses to
award Ms. Ledger incentive-based compensation partially in the form of
options, and chooses to defer the vesting of those options, no more
than $38,250 worth of those options (the equivalent of 15 percent of
the aggregate incentive-based compensation awarded to Ms. Ledger) would
be eligible to be treated as deferred incentive-based
compensation.\248\ As an example, ABC may award Ms. Ledger options that
have a value at the end of the performance period of $10 and deferred
vesting. ABC may choose to award Ms. Ledger incentive-based
compensation with a total value of $255,000 in the following forms:
$30,000 in cash, 640 shares of equity (valued at $32,000), and 1,800
options (valued at $18,000) under the Annual Executive Plan; $35,000
cash under the Annual Firm-Wide Plan; and $40,000 cash, 1,600 shares of
equity (valued at $80,000), and 2,000 options (valued at $20,000) under
Ms. Ledger's LTIP. Of that award, ABC may defer: $27,500 in cash, 290
shares (valued at $14,500), and 1,800 options (valued at $18,000) under
the Annual Executive Plan (total value of deferred $60,000); none of
the award from the Annual Firm-Wide Plan; and $35,000 in cash, 300
shares (valued at $15,000) and 2,000 options (valued at $20,000) under
Ms. Ledger's LTIP (total value of deferred $70,000). The total value of
options being counted as deferred incentive-based compensation would be
$38,000, which would be 14.9 percent of the total incentive-based
compensation awarded ($255,000). Assuming the vesting schedule is
consistent with the proposed rule, Ms. Ledger's incentive-based
compensation arrangement would be consistent with the proposed rule,
because: (1) The value of Ms. Ledger's deferred incentive-based
compensation under the Annual Executive Plan (which comprises all of
Ms. Ledger's deferred qualifying incentive-based compensation) is more
than 50 percent of the value of Ms. Ledger's total qualifying
incentive-based compensation award ($115,000) and (2) the value of Ms.
Ledger's deferred incentive-based compensation under Ms. Ledger's LTIP
is 50 percent the value of Ms. Ledger's incentive-based compensation
awarded under a long-term incentive plan ($140,000).
---------------------------------------------------------------------------

    \248\ See section __.7(a)(4)(ii).

                                       Alternative Scenario 1: Deferred Options Consistent With the Proposed Rule
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                Total award amounts
                                                         -----------------------------------------------------------------------------------------------
              Incentive-based compensation                                                   Value of                        Value of       Total value
                                                             Cash ($)       Equity (#)      equity ($)      Options (#)     options ($)         ($)
--------------------------------------------------------------------------------------------------------------------------------------------------------
Annual Executive Plan...................................         $30,000             640         $32,000           1,800         $18,000         $80,000
Annual Firm-Wide Plan...................................          35,000  ..............  ..............  ..............  ..............          35,000
Ms. Ledger's LTIP.......................................          40,000           1,600          80,000           2,000          20,000         140,000
                                                         -----------------------------------------------------------------------------------------------
    Total...............................................         105,000           2,240         112,000           3,800          38,000         255,000
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                Amounts immediately payable
--------------------------------------------------------------------------------------------------------------------------------------------------------
Annual Executive Plan...................................          $2,500             350         $17,500  ..............  ..............          20,000
Annual Firm-Wide Plan...................................          35,000  ..............  ..............  ..............  ..............          35,000
Ms. Ledger's LTIP.......................................           5,000           1,300          65,000  ..............  ..............          70,000
                                                         -----------------------------------------------------------------------------------------------

    Total...............................................          42,500           1,650          82,500  ..............  ..............         125,000
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                Total deferred amounts
--------------------------------------------------------------------------------------------------------------------------------------------------------
Annual Executive Plan...................................         $27,500             290         $14,500           1,800         $18,000         $60,000
Annual Firm-Wide Plan...................................  ..............  ..............  ..............  ..............  ..............  ..............
Ms. Ledger's LTIP.......................................          35,000             300          15,000           2,000          20,000          70,000
                                                         -----------------------------------------------------------------------------------------------
    Total...............................................          62,500             590          29,500           3,800          38,000         130,000
--------------------------------------------------------------------------------------------------------------------------------------------------------

------------------------------------------------------------------------

------------------------------------------------------------------------
Aggregate Incentive-Based Compensation Awarded.............     $255,000
Option Value at 15% Threshold Maximum......................       38,250
Minimum Qualifying Incentive-Based Compensation--Deferral         57,500
 at 50%....................................................
Minimum Incentive-Based Compensation Required under a Long-       70,000
 Term Incentive Plan--Deferral at 50%......................
------------------------------------------------------------------------

    In contrast, if ABC chooses to award Ms. Ledger more options than
in the example above, Ms. Ledger's incentive-based compensation
arrangement may no longer be consistent with the proposed rule. As a
second alternative scenario, ABC may choose to award Ms. Ledger
incentive-based compensation with a total value of $255,000 in the