Behavioral Science for Incentive Compensation Reviews

Recent attention in Congress on retail incentive compensation, goal-setting and cross-selling of consumer financial products and services is remarkable for its ferocity and its direction at banks and regulators alike. During a Sept. 20, 2016, Senate Committee on Banking, Housing and Urban Affairs hearing, Senator Elizabeth Warren, D-Mass., called out for special attention to “the person in charge of compliance ... the person who is supposed to be responsible to make sure that the bank is following the law.”

During a Sept. 29, 2016, House Financial Services Committee hearing Congressman Blaine Luetkemeyer, R-Mo., pilloried, “federal regulators who ... failed to stop the ripping off of consumers” and “sat idly by, either oblivious or uncaring,” and then “neglected to fulfill their enforcement obligations after the fact.” He suggested that regulators “ought to be fined, as well” for being “asleep at the switch.”

Incentive compensation is not a new subject for financial services policymakers. According to a 2009 survey of banking organizations conducted by the Institute of International Finance, 98 percent of respondents cited compensation practices as a contributing cause of the financial crisis that began in 2007. Less than a month before the passage of the Dodd-Frank Act, federal bank regulators published “Guidance on Sound Incentive Compensation Policies.” Section 956 of the Dodd-Frank Act itself addresses incentive compensation and requires, among other things, that federal agencies promulgate rules limiting at certain financial institutions incentive-based compensation that, in the regulators’ view, encourages inappropriate risks.

A 2011 proposed rule implementing this statutory requirement generated over 10,000 comments. Perhaps due to divergent views on the subject, there was no formal action on the rulemaking for five years, until the agencies issued a revised proposal in June 2016 — not long before the current incentive compensation controversy hit the headlines. It is safe to say that the subject has been quickly graduated to the regulators’ front burner.

Originally published in Law360; reprinted with permission.