Thank you, Chairman Schapiro.
I join my colleagues in thanking the staff for your efforts on this rulemaking.
Section 956 of the Dodd-Frank Act provides, most notably, that the Commission, jointly with other financial regulators, must adopt regulations or guidelines that prohibit incentive-based compensation arrangements that encourage “inappropriate risks” by a “covered financial institution” (1) by providing “excessive compensation” or (2) that “could lead to material financial loss.” The term “covered financial institution” includes broker-dealers and investment advisers with assets of $1 billion or more. Section 956 thus implicates the SEC’s jurisdiction. The recommendation before us goes toward giving effect to this provision of Dodd-Frank.
Unfortunately, I am not able to support the proposal and respectfully dissent. My primary objections relate to the rulemaking’s approach toward regulating incentive-based compensation arrangements at broker-dealers and investment advisers, as well as other financial institutions, with assets of $50 billion or more. The recommendation, for example, is to mandate that at least 50 percent of the incentive-based compensation of an executive officer at such a firm be deferred for at least three years; that the deferred amounts be paid out no faster than pro rata; and that the deferred amounts be adjusted, or “clawed back,” to reflect actual losses at the firm during the deferral. The recommendation also provides that the compensation arrangements of certain designated risk takers, other than executive officers, must be approved by the board and that the board, in assessing an individual’s compensation, must account for certain factors that the rule enumerates.
The following captures three of my core concerns with the proposal.
First, the prescriptive regulatory approach reflected in the mandatory deferral requirement is ill-advised. Financial institutions are diverse and complex and different individuals behave differently, meaning that what makes for an optimal compensation arrangement can vary firm-by-firm and individual-by-individual. The optimal compensation arrangement for an individual also can change over time depending upon a host of shifting facts and circumstances. More generally, given that the proposal ultimately speaks to risk management, it is important to recognize that the right approach to managing risk can vary across firms depending on each firm’s structure, operations, and activities. Simply put, then, the Commission is not well-equipped to prescribe rules that dictate the specifics of how individuals must be paid.
Second, larger broker-dealers and investment advisers may find it more difficult to recruit and retain quality personnel, thus potentially compromising the competitiveness and capability of these financial institutions.
Third, I am concerned that the proposal, if adopted, would lead individuals at covered broker-dealers and investment advisers to become unduly conservative and avoid taking even prudent risks. This prospect is troubling; for while it is appropriate to recognize the potential for excessive risk taking, we also must recognize that firms can take too few risks. A regulatory regime that places undue emphasis on reducing the likelihood of bad outcomes is costly if it leads to excessive conservatism. An innovative private sector that spurs economic growth depends on the willingness of enterprises to take risks.
In sum, the risk of unintended consequences is considerable when regulators try to micromanage individuals’ incentives to the degree and in the way that this rulemaking does.
Notwithstanding that I am unable to support the recommendation, I nonetheless look forward to the comments we will receive. I particularly welcome comments that address whether it is appropriate to treat broker-dealers and investment advisers differently from other financial institutions, such as banks. Although this is a joint rulemaking among financial regulators, there is, as I understand it, room to treat different types of financial institutions differently.