SEC Proposes New Incentive-Based Compensation Rule for Advisers

May 6, 2016

The SEC released a proposed rule that would govern the implementation of incentive-based compensation arrangements for certain “covered financial institutions,” including investment advisers. The new rule would apply to advisers with total consolidated assets (i.e., balance sheet assets) of at least $1 billion, as measured at fiscal year-end. The SEC noted in the proposing release that the total consolidated assets should not include “non-proprietary assets,” such as client assets under management.

The new rule would prohibit an adviser that has at least $1 billion in total consolidated assets from establishing or maintaining incentive-based payment compensation arrangements that encourage inappropriate risks (i) by providing excessive compensation, fees, or benefits to an executive officer, employee, director, or principal shareholder or (ii) that could lead to material financial loss.

Compensation would be considered excessive when amounts paid are unreasonable or disproportionate to the value of the services performed by a covered person, taking into consideration all relevant factors, including:

  • The combined value of all compensation, fees, or benefits provided to a covered person;
  • The compensation history of the covered person and other individuals with comparable expertise at the covered institution;
  • The financial condition of the covered institution;
  • Compensation practices at comparable institutions, based upon such factors as asset size, geographic location, and the complexity of the covered institution’s operations and assets;
  • For post-employment benefits, the projected total cost and benefit to the covered institution; and
  • Any connection between the covered person and any fraudulent act or omission, breach of trust or fiduciary duty, or insider abuse with regard to the covered institution.

An incentive-based compensation arrangement would be considered to encourage inappropriate risks that could lead to material financial loss to the covered institution, unless the arrangement:

  • Appropriately balances risk and reward, which at a minimum means that the arrangement (i) includes financial and non-financial measures of performance; (ii) is designed to allow non-financial measures of performance to override financial measures of performance, when appropriate; and (iii) is subject to adjustment to reflect actual losses, inappropriate risks taken, compliance deficiencies, or other measures or aspects of financial and non-financial performance;
  • Is compatible with effective risk management and controls; and
  • Is supported by effective governance.

The board of directors (or a committee thereof) for each covered adviser would be required to: (i) conduct oversight of the covered institution’s incentive-based compensation program; (ii) approve incentive-based compensation arrangements for senior executive officers, including amounts of awards and, at the time of vesting, payouts under such arrangements; and (iii) approve material exceptions or adjustments to incentive-based compensation policies or arrangements for senior executive officers.

Click here to access the proposed rule.



Investment Advisers