New Incentive Compensation Rules: Implications for Private Equity Firms

2 May 2016
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Key takeaways

  • U.S. financial regulatory agencies have been working together since 2011 to issue regulations under Section 956 of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 to curb excessive compensation practices that many believe led to the 2008 financial crisis. Several of the agencies have released revised proposed rules that provide a preview of what to expect from the other agencies.
  • The proposed rules aim to prohibit covered financial institutions, including investment advisers, from providing incentive compensation arrangements that encourage “inappropriate” risk-taking (1) by providing “excessive” compensation or (2) that could lead to material financial loss.
  • The proposed rules would apply to investment advisers with more than $1 billion in total assets, with more stringent requirements applying to covered financial institutions above a $50 billion threshold.  Because the new rules make clear that non-proprietary assets are not included in the determination of asset thresholds, even if included on a PE Manager’s balance sheet, PE Managers are unlikely to be subject to the more stringent requirements, and many will avoid regulation altogether.
  • Certain requirements apply to all covered financial institutions, including requirements to take into account both financial and nonfinancial risk-based measures in determining incentive-based compensation for all employees, with additional requirements to downwardly adjust compensation for risk failures.  These requirements may necessitate changes in the way covered PE Managers structure their compensation arrangements going forward.