Dodd-Frank Interagency Rule: What Does It Mean for Credit Unions?
Wall Street reform may be what the Dodd-Frank Act is intended to accomplish, but as usual, those financial institutions that followed the rules and operated with the best interests of their customers in mind end up shouldering a new burden because of a bunch of bad actors who didn’t.
The Office of the Comptroller of the Currency, the Federal Reserve, the FDIC, the Office of Thrift Supervision , the SEC, the FHFA and the NCUA have jointly prescribed an interagency rule to implement Section 956 of Dodd-Frank.
Under the NCUA’s version of the proposed interagency rule, credit union boards will have to ratchet up board and management knowledge, oversight and policymaking on executive compensation. The rule will directly affect all credit unions with more than $1 billion in assets. Fundamentally, the rule applies to less than 200 credit unions out of approximately 7,500 nationwide. These billion plus credit unions will have to report to the NCUA on their executive incentive compensation practices, methodology and the underlying assumptions about how they structure incentive or “at risk” pay for their executives.
- Under the rule, all credit unions with $1 billion or more in assets must:
- Develop and maintain sound incentive compensation policies,
- Submit reports on executive incentive compensation to the NCUA annually,
- Avoid providing “excessive” compensation, and
Construct incentives so that they don’t encourage executives to take “inappropriate risks” that could lead to material loss.
Credit unions with $10 billion or more in assets would face an additional requirement to defer at least 50% of their incentive compensation over at least three years.
The goal of the interagency rule is to reward executives of financial entities for sustainable growth, not the short-term blips that don’t benefit anyone in the long run. Essentially, the rule said that credit unions should operate in the best interests of their members over the long term. Why should we even need a rule to tell us that?
The promulgation of these new rules may signal a need to rethink our assumptions about executive compensation. Instead of the view that CEOs are driven more by money than by the good of the organization and their own feelings of accomplishment, an incentive payment should be the reward that comes after the fact for doing one’s job up to or better than expectations. People are motivated by values and rewarded with money.
The real challenge is using the right metrics to measure sustainable and relevant performance, which may vary widely from credit union to credit union. Credit unions utilize different criteria to measure their performance, and that is appropriate. But, it seems only logical that all credit unions should start with the premise that what is in the best interests of members and the organization should drive incentives.
The scope and affect of the proposed rule on existing incentive compensation and deferred compensation arrangements need to be defined. Existing 457(f) arrangements should be grandfathered and unaffected. Also, the distinction between incentive-based compensation and deferred compensation arrangements must be clarified. Credit unions must be able to reasonably attract, reward, and retain key executive talent and also to provide nonqualified plan benefits to supplement retirement income. Additionally, there needs to be a clear line between retirement and retention plans, such as 457(f) and 457(b) plans, and those types of plans subject to the interagency rule.
While the proposal creates an important framework to limit potential abuses that might arise from excessive compensation or compensation that encourages inappropriate risk taking, the vesting, distribution, and adjustments required in the event of unsustainable performance should be clarified. Distinctions should also be provided as to the clearly different platform and intent of retention and retirement plans that are not necessarily based on performance measurements.
Taking a long term look at financial performance, risk management and compliance is the best way to get a true measure of what performance deserves an incentive payment. However, those financial measurements are really derivations of a more basic and underlying view of the real business of a credit union: providing the best sustainable experience for its members.
Jane Upton is a principal at Executive Compensation Solutions. Contact 626-914-2333 or firstname.lastname@example.org