How does the Volcker Rule address the use of prohibited compensation arrangements?

The Volcker Rule, a component of the Dodd-Frank Wall Street Reform and Consumer Protection Act, includes provisions aimed at addressing the use of prohibited compensation arrangements by banking entities. These provisions are designed to discourage practices that might incentivize excessive risk-taking or non-compliance with the rule. Specifically, the Volcker Rule includes the following provisions related to compensation arrangements:

1. Clawback Provisions: The Volcker Rule requires banking entities to establish and maintain policies and procedures that provide for the recovery (clawback) of incentive-based compensation from employees in cases where it is determined that the compensation was based on inaccurate financial information or other metrics that later prove to be materially inaccurate. This provision is intended to discourage employees from engaging in activities that could lead to inaccurate reporting or risky behavior.

2. Deferral of Incentive-Based Compensation: Banking entities must defer a portion of the incentive-based compensation awarded to certain employees. The deferred compensation is subject to forfeiture or reduction based on the performance of the banking entity and the individual's activities. This provision aims to align the interests of employees with the long-term stability and performance of the entity and discourage excessive risk-taking.

3. Specific Rules for Senior Executive Officers and Major Risk Takers: The Volcker Rule imposes stricter requirements on the deferral and forfeiture of incentive-based compensation for senior executive officers and individuals identified as major risk takers. These individuals are subject to more stringent rules to ensure that their compensation is tied to the safety and soundness of the banking entity.

4. Prohibition on Hedging: The rule generally prohibits banking entities from entering into compensation arrangements that would allow employees to hedge or offset any incentive-based compensation that is subject to deferral or forfeiture. The intent is to ensure that employees do not undermine the risk-mitigation goals of the rule through hedging activities.

5. Enhanced Supervision and Enforcement: Regulatory agencies are responsible for overseeing compliance with the compensation-related provisions of the Volcker Rule. Banking entities are required to report information to regulators to demonstrate compliance with these provisions. Failure to comply can result in regulatory enforcement actions, including fines and penalties.

6. Additional Regulations and Guidance: Regulatory agencies have issued additional regulations and guidance to provide further details on the implementation and interpretation of the compensation-related provisions of the Volcker Rule. These regulations specify, among other things, the criteria for identifying individuals subject to the rule's requirements and the specific metrics for deferral and forfeiture of incentive-based compensation.

The goal of these compensation-related provisions is to ensure that employees of banking entities do not engage in activities that could pose excessive risks to the financial institution or the broader financial system. By tying compensation to long-term performance and incorporating clawback mechanisms, the Volcker Rule aims to create stronger incentives for responsible behavior and risk management within the banking industry.