The Fed Releases an Important Paper on Risk and Incentive Compensation

Last week, the Board of Governors of the Federal Reserve System published a white paper, titled "Incentive Compensation Practices: A Report on the Horizontal Review of Practices at Large Banking Organizations." Often, government reports like this are not useful because they are theoretical and not legally binding in any way. In fact, some press reports have focused on the first section of the Report, which argues that compensation policies were partly to blame for the financial crisis. However, for those of us who live and work in this area every day, this Report is actually quite useful when you get past the first couple of pages – and not just for financial institutions.

1. Financial institutions that were (fortunate enough) not subject to the Horizontal Review can learn about the Fed's opinions toward incentive compensation and risk from the Report, e.g., what works, what doesn't work, and what institutions need to do.

2. Because the Report gathers together all of the Fed's observations and opinions (and guidance) with respect to all of the issues at all of the institutions subject to the Horizontal Review, even a large banking organization (LBO) that was put through the Horizontal Review can learn about the Fed's opinion toward forms of incentive compensation, deferral, involvement of the board and risk management professionals, documentation, etc., other than those the institution actually used (or proposed) and discussed with the Fed in its own review.

3. Finally, even if you are not working for or advising a financial institution, these rules are likely to become a template for future government regulation in this area (see: TARP–Dodd-Frank Act).

Because (i) several of the concepts on balance risk and incentive compensation are likely to show up in future legislation or regulation, and (ii) the Report is lengthy and very detailed, I will discuss this Report further in subsequent blogs.

On an unrelated note, I will be delivering my presentation on "Ethics, Conflicts and Privilege Issues in Executive Compensation – Updated for the Dodd-Frank Provisions on Independent Counsel" tomorrow at the Ohio Chapter of NASPP (in Cincinnati), in case you are nearby.

On October 10, 1845, the Naval School opened in Annapolis, Maryland, with 50 midshipmen students and seven professors. The Naval School was founded by Secretary of the Navy, George Bancroft, on 10 acres of old Fort Severn in Annapolis, at the confluence of the Severn River and Chesapeake Bay. In 1850 it became the United States Naval Academy and is the second-oldest of the five service academies. The beautiful campus is now 338 acres and a National Historic Landmark, and only 33 miles from Washington, D.C. and 26 miles from Baltimore.