On March 2, the SEC approved a draft of a proposed rule that would (1) require certain financial institutions to disclose the design of their incentive-based compensation arrangements and (2) prohibit companies from implementing compensation arrangements that would promote excessive risk.

The draft proposal was released in response to Section 956 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, which calls for the SEC and other agencies to write joint rules and guidelines. While the SEC has approved the draft proposal, six other federal agencies must also approve it. After such approval, it will be published in the Federal Register, and the draft proposal on the SEC’s Web site will be replaced with the final version.

In a press release, SEC Chairman Mary Shapiro indicated that the SEC staff has “worked closely with other federal regulators and the proposal reflects a series of carefully considered compromises.” Accordingly, it is unclear to what extent the provisions of the current draft proposed rule may change.

Under the draft proposal:

• Institutions would be required to file annual reports that discuss their incentive-based compensation arrangements. Such reports would include, but not be limited to, the following:
• A narrative description of components.
• A concise description of policies and procedures governing such arrangements.
• A statement describing how the structure of such arrangements prevents (1) excessive compensation and (2) a material financial loss to the entity.
• Incentive-based compensation plans that encourage inappropriate risk would be prohibited. In addition, for covered entities whose assets exceed $50 billion, at least 50 percent of incentive-based executive compensation would have to be deferred for three years. The proposed rule assigns certain responsibilities to the board of directors (or a committee of the board), such as identifying and approving compensation arrangements for “covered persons, other than executive officers, that individually have the ability to expose the firm to possible losses that are substantial.”
• Institutions would need to establish policies and procedures that require an incentive-based compensation arrangement to be adopted and approved by their board of directors.

Comments on the proposed rule will be due 45 days after it is published in the Federal Register.