As I discuss in my paper Regulating Compensation, the Dodd-Frank Act directed the SEC and other appropriate agencies to promulgate rules regarding compensation practices at publicly-held corporations in general and "covered financial institutions" specifically.  Section 956 of the Act specifically directs

Federal regulators shall jointly prescribe regulations or guidelines that prohibit any types of incentive-based payment arrangement, or any feature of any such arrangement, that the regulators determine encourages inappropriate risks by covered financial institutions— (1) by providing an executive officer, employee, director, or principal shareholder of the covered financial institution with excessive compensation, fees, or benefits; or (2) that could lead to material financial loss to the covered financial institution.

So, after almost nine months, the FDIC has proposed rules, and as of yesterday, so has the SEC.  (Here is Larry Cunningham's positive review of the FDIC's rules.)  One of my concerns is how can the SEC, which has not proven to be an agile agency capable of spotting potential risks, determine for each employee at each covered financial institution which kinds of compensation plans will be "excessive" and which "could lead" to "material financial loss."  What is excessive?  What is the probability, and what threshold of probability concerns us?  And which losses are material?  These are hefty questions, and ones that I'm not sure that the SEC has the manpower or expertise to determine on a case-by-case basis.

But, of course, the SEC must have provided us some guidelines in their proposed rule, right?   Here's what we have so far:

1) Disclosures About Incentive-Based Compensation Arrangements

Under the proposed rules, a covered financial institution would be required to file annually with its appropriate federal regulator a report describing the firm’s incentive-based compensation arrangements.  The information submitted would include but not be limited to:

A narrative description of the components of the firm’s incentive-basedcompensationarrangements.

A succinct description of the firm’s policies and procedures governing its incentive-based compensation arrangements.

A statement of the specific reasons as to why the firm believes the structure of its incentive-based compensation arrangement will help prevent it from suffering a material financial loss or does not provide covered persons with excessive compensation.

2) Prohibition on Encouraging Inappropriate Risk General prohibitions

The proposed rule applies to executive officers, employees, directors, or principal shareholders – “covered persons” – at a covered financial institution.

Under the proposed rule, a covered financial institution would be prohibited from establishing or maintaining an incentive-based compensation arrangement that encourages inappropriate risks by providing covered persons with excessive compensation, or that could lead to material financial loss.

The proposal states that incentive-based compensation arrangements would be deemed to encourage inappropriate risks unless the incentive-based compensation arrangements meet certain standards, which are drawn from standards established in prior legislation and from guidance published by bank regulators last July.

This proposal seems to merely parrot back the text of Section 956.  The "prior legislation" seems to refer to the June 2010 FDIC guidance, which itself does not define these terms.  As Larry C. points out, the FDIC "final guidance" is a listing of principals, which talk of balancing risk and reward.  Larry likes flexible principals.  If I needed to know if my compensation were going to be cut by strangers, I would want to know what their criteria was going to be.

The SEC voted to propose these rules with two dissenting votes, including the vote of Commissioner Troy Paredes.  Here are his comments, which state his three concerns:  (1) the difficulty in assessing appropriate compensation across individuals, across firms and across time: (2) the ability of firms to recruit talent and remain competitive; and (3) the danger of encouraging sub-optimal risk-taking.

At a conference a few weeks ago, a paper cited a quote from the Economist in 2009:  "When a fight breaks out in a bar, you don't hit the man who started it.  You clobber the person you don't like instead."  The article and the paper were about regulating hedge funds, a modern-day villain.  However, I think the quote is at least as apt to describe the post-crisis push to regulate compensation.  Yes, the executives at the banks that made poor decisions in the mid-2000s were paid a lot of money.  But I would think more than correlation is necessary before sweeping compensation prohibitions are instituted.

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