• House Passes Legislation That Would Require Reporting of Incentive-Based Compensation Arrangements and Could Lead to Restrictions on Compensation for Certain Investment Advisers
  • August 17, 2009 | Authors: Richard A. Goldman; Stephen C. Tirrell; Alisha D. Telci
  • Law Firm: Bingham McCutchen LLP - Boston Office
  • On July 31, 2009, the House of Representatives passed “say-on-pay” legislation that includes provisions requiring “appropriate Federal regulators”1 to prescribe regulations to require certain financial institutions, including investment advisers to hedge funds and private equity funds with assets of at least $1 billion, to report incentive-based compensation arrangements. Certain provisions were also included in the House legislation that could enable the Federal government to place caps or other restrictions on compensation received by financial institutions, including investment advisers.

    According to Financial Services Committee Chairman Barney Frank, the Corporate and Financial Institution Compensation Fairness Act of 2009 “responds to the broad consensus among economic analysts and regulators that flawed compensation systems have provided excessive risk which has contributed to the recent systemic problems in the financial marketplace.” The primary focus of the bill is the say-on-pay provisions that would provide shareholders with an advisory vote concerning compensation for executives of public companies. However, the bill also contains requirements concerning incentive-based compensation arrangements for “covered financial institutions” with over $1 billion in assets, including banks, registered broker-dealers, credit unions, investment advisers as defined under the Investment Advisers Act of 1940 (which includes both registered and unregistered advisers), and any other financial institution that the appropriate Federal regulators jointly determine should be treated as a covered financial institution.

    The bill would require the appropriate Federal regulators to jointly prescribe regulations within nine months of the bill’s enactment to require each covered financial institution to disclose to such regulators the structures of all incentive-based compensation arrangements, sufficient to determine whether the compensation structure (i) is aligned with sound risk management; (ii) is structured to account for the time horizon of risks; and (iii) meets other criteria as the appropriate Federal regulators may determine to be appropriate to reduce unreasonable incentives for employees to take undue risks that “could threaten the safety and soundness of covered financial institutions or could have serious adverse effects on economic conditions or financial stability.” Reporting of actual compensation of particular individuals would not be required. The bill would also require federal regulators to jointly prescribe regulations prohibiting any incentive-based arrangement, or any feature of any such arrangement, that the regulators determine to encourage inappropriate risks by covered financial institutions or that could pose the type of systemic risks set out above.

    The bill would also require the GAO to study the data provided by financial institutions to determine if there is a correlation between their compensation structures and excessive risk-taking. The GAO would consider compensation structures used by companies from 2000 to 2008 and compare companies that failed, or nearly failed, but for government assistance, to companies that remained viable throughout the housing and credit market crisis of 2007 and 2008.

    The legislation, while clear in its goal of preventing systemic risk, would leave the specifics of rulemaking and providing any interpretive guidance largely to the joint responsibility of the appropriate Federal regulators. This would leave many details to be determined. For example, although the bill exempts investment advisers who do not have incentive-based compensation arrangements from any disclosure requirements, the types of compensation arrangements that are considered incentive-based will need to be defined. Also, the legislation exempts covered financial institutions “with assets of less than $1,000,000,000.” Although unclear, it would appear that the intention of the bill was to refer to an investment adviser’s assets under management.

    The House bill next heads to the Senate for consideration. The Senate has previously considered say-on-pay legislation for public companies that was co-sponsored by then-Senator Barack Obama, although such legislation did not contain the provisions regarding incentive-based compensation for covered financial institutions. At this time, it is unclear whether these provisions will remain in any say-on-pay legislation that the Senate might pass. We understand that Senate leadership is considering whether to include say-on-pay legislation with other financial services reform proposals or to separately consider it as stand-alone legislation. The majority is hoping to enact a broad and comprehensive reform package by the end of this year, but it remains unclear if an omnibus package, or any piece thereof, will be politically viable in the midst of congressional consideration of other politically charged items, such as health insurance reform, climate change and fiscal year 2010 appropriations.