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Nutter Bank Report, April 2016

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The Nutter Bank Report is a monthly publication of the firm's Banking and Financial Services Group.

1. FDIC Approves Proposed Rule to Limit Incentive-Based Compensation Arrangements
2. Congress Considers Expanding Asset Threshold for Small Bank Holding Companies
3. FDIC Publishes New Guidance on Community Bank Corporate Governance
4. Department of Labor Expands the Definition of a Fiduciary for ERISA Plans and IRAs
5. Other Developments: Assessments, Loan File Reviews and Deposit Insurance Applications

1. FDIC Approves Proposed Rule to Limit Incentive-Based Compensation Arrangements

The FDIC has approved a proposed a rule that will be issued jointly with the other federal banking agencies, the Securities and Exchange Commission, and the Federal Housing Finance Agency that would limit certain types of incentive-based compensation arrangements. The proposal approved on April 26 would implement Section 956 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), which prohibits incentive-based compensation arrangements that are deemed to be excessive, may lead to material losses, or encourage inappropriate risk taking by certain financial institutions, including banks, thrifts, and their holding companies. The agencies first proposed a rule to implement Section 956 in April 2011. Similar to the 2011 proposal, the current proposed rule would not apply to financial institutions with total consolidated assets of less than $1 billion. The proposed rule identifies three categories of covered institutions based on average total consolidated assets: Level 1, greater than or equal to $250 billion; Level 2, greater than or equal to $50 billion and less than $250 billion; and Level 3, greater than or equal to $1 billion and less than $50 billion. The proposed rule contains progressively more rigorous standards for Level 2 and Level 1 institutions. The prohibition against incentive-based compensation arrangements that provide excessive compensation or could lead to a material financial loss would apply to all covered institutions. The proposed rule would also require all covered institutions to have controls in place commensurate with the size and complexity of the institution for the design, implementation, and monitoring of incentive-based compensation arrangements to ensure that processes to appropriately balance risk and reward are followed, and that the integrity of risk management and other control functions are maintained. The current proposed rule replaces an annual reporting requirement from the 2011 proposal with recordkeeping requirements for incentive-based compensation arrangements. Comments on the proposed rule will be due within 45 days after publication in the Federal Register, which will not occur until the other federal agencies adopt the proposed rule. Click here for a copy of the proposed rule approved by the FDIC.

    Nutter Notes: Similar to the 2011 proposal, the current proposed rule provides that compensation, fees, and benefits will be considered excessive when amounts paid to any one person are “unreasonable or disproportionate to the value of the services performed” taking into account relevant factors that include the combined value of all compensation provided to that person, the compensation history of the person and others with comparable expertise, and the financial condition of the covered institution. Other factors include the compensation practices at comparable institutions, the projected total cost and benefit to the covered institution for post-employment benefits, and any connection between the person and any fraudulent act or omission, breach of trust or fiduciary duty, or insider abuse related to the covered institution. Also similar to the 2011 proposal, the current proposed rule provides that an incentive-based compensation arrangement will be considered to encourage inappropriate risks that could lead to material financial loss unless the arrangement “[a]ppropriately balances risk and reward, [i]s compatible with effective risk management and controls, and [i]s supported by effective governance.” Unlike the 2011 proposal, the current proposed rule clarifies that an incentive-based compensation arrangement would not be considered to appropriately balance risk and reward unless it includes both financial and non-financial measures of performance, allows non-financial measures of performance to override financial measures, when appropriate, and is subject to adjustment to reflect losses, inappropriate risks, compliance deficiencies or other financial and nonfinancial performance measures. For Level 1 and Level 2 covered institutions, the proposed rule would also require that certain incentive-based compensation arrangements include deferral of payments, risk of downward adjustment, and forfeiture and clawback provisions.

2. House Approves Bill to Expand Asset Threshold for Small Bank Holding Companies

Congress is considering a bill, H.R. 3791, that would expand the applicability of the Federal Reserve’s Small Bank Holding Company Policy Statement from qualifying bank and savings and loan holding companies with $1 billion in total consolidated assets to holding companies with $5 billion in total consolidated assets. The House of Representatives on April 14 voted to pass H.R. 3791, which would also amend Section 171 of the Dodd-Frank Act to clarify that the exemption it grants to small bank holding companies from minimum leverage and risk-based capital requirements must also be applied to qualifying savings and loan holding companies. The Policy Statement allows qualifying holding companies of small community banks and savings associations to operate with higher levels of debt than would normally be permitted. Holding companies that qualify for the Policy Statement are excluded from consolidated capital requirements, though their subsidiary depository institutions continue to be subject to minimum capital requirements. Holding companies that fall under the asset threshold of the Policy Statement must also meet certain qualitative requirements, including those pertaining to nonbanking activities, off-balance sheet activities, and publicly-registered debt and equity. The Federal Reserve retains the right to exclude any bank holding company or savings and loan holding company, regardless of size, from the Policy Statement if the Federal Reserve Board determines that it is necessary for supervisory purposes. Click here for the text of the bill.

    Nutter Notes: H.R. 3791 was referred to the Senate Committee on Banking, Housing, and Urban Affairs on April 18. In addition, the White House issued a statement on April 12 opposing the bill on the basis that raising the threshold to exempt holding companies with over $1 billion in total assets from minimum leverage and capital requirements might encourage them to take on debt levels that could endanger their safety and soundness. The White House statement also indicated that the President’s senior advisors would recommend a veto if the bill is presented to him to be signed into law. The Federal Reserve recently issued a final rule that raised the asset threshold of the Policy Statement from $500 million to $1 billion in total consolidated assets and expanded the applicability of the Policy Statement to savings and loan holding companies that meet qualifying criteria similar to those for small bank holding companies. The qualitative requirements that small holding companies must meet to qualify for the Policy Statement are that the holding company must not be engaged in significant nonbanking activities, either directly or through a nonbank subsidiary, does not conduct significant off-balance sheet activities, and does not have a material amount of debt or equity securities outstanding (other than trust preferred securities) that are registered with the Securities and Exchange Commission.

3. FDIC Publishes New Guidance on Community Bank Corporate Governance

The FDIC has issued new guidance on community bank corporate governance matters, including expanded commentary on the FDIC Pocket Guide for Directors, which was last updated in 2007. The new guidance was released on April 5 as a special edition of Supervisory Insights, the newsletter published by the FDIC’s Division of Risk Management Supervision. The new guidance highlights key governance concepts, roles, and responsibilities of directors and senior management, and discusses how FDIC examiners evaluate governance at community banks. For example, expanding on the Pocket Guide’s advice about directors’ responsibility for selecting and retaining qualified management, the new guidance recommends that bank directors consider implementing a management succession and talent development plan to “build bench strength” and identify possible successors for the chief executive and other key senior management positions. The guidance also describes supervisory expectations for the duties of directors to keep informed and work with management to set business objectives. According to the new guidance, a community bank’s directors should have a solid understanding of the bank’s risk profile to set appropriate business objectives and properly monitor operations and supervise management. The new guidance advises that evaluating a bank’s risk profile goes beyond current conditions and involves assessing the riskiness of the bank’s business model, evaluating how the bank manages the risks related to that business model and growth plans, and considering potential external threats. Click here for the corporate governance edition of Supervisory Insights.

    Nutter Notes: While there have been no new changes to the Pocket Guide and, in the FDIC’s view, the core principles of being a bank director have not changed materially, the FDIC said that bank directors may benefit from the discussion in the special edition of Supervisory Insights of recent corporate governance lessons and experiences of other bankers and bank supervisors. The guidance emphasizes the importance of directors setting a “tone from the top.” According to the guidance, it has been the FDIC’s experience that directors lay a foundation for prudent oversight when they send “a clear message to staff that they value a strong risk management culture that includes a strong ethical culture.” The guidance describes “risk management culture” as the system of goals, objectives, policies, controls, values and behaviors that influence risk decisions.” The guidance describes “ethical culture” as the belief that the interests of a bank’s customers and other stakeholders take precedence over short-term profits. The guidance urges directors to review the FDIC’s Corporate Codes of Conduct, Guidance on Implementing an Effective Ethics Program, issued in 2005, for a better understanding of examiners’ expectations about directors’ responsibility for establishing policies on ethics and corporate conduct, including the expectation that community bank directors should ensure that a bank has certain minimum policies in place. According to the guidance, such policies include safeguarding confidential information, ensuring the integrity of records, providing strong internal controls over assets, and providing candor in dealing with auditors, examiners, and legal counsel.

4. Department of Labor Expands the Definition of a Fiduciary for ERISA Plans and IRAs

The Department of Labor (“DOL”) has issued a final rule that significantly expands who is considered a “fiduciary” under the Employee Retirement Income Security Act of 1974 (“ERISA”) as a result of giving investment advice to an employee benefit plan or its participants or beneficiaries. The new definition of a fiduciary under the final rule released on April 6 also applies to certain non-ERISA plans under the Internal Revenue Code of 1986 (the “Code”), such as individual retirement accounts (“IRAs”). The final rule treats persons, including banks, who provide investment advice or recommendations for a fee or other compensation with respect to assets of a plan or IRA as fiduciaries in a wider array of advice relationships. As a result of the new rule, any bank that offers retirement products and services will need to determine whether its activities related to employee benefit plans and IRAs constitute “investment advice,” and if so, also determine to what extent the bank must adjust its practices to conform to the new fiduciary rule. In the release accompanying the final rule, the DOL also clarified what does and does not constitute investment advice under the fiduciary rule, and provided examples of communication that would not rise to the level of investment advice. The final rule becomes effective on June 7, 2016, though the DOL has also decided to delay the application of certain requirements for some exemptions to the rule, which will allow some institutions to be temporarily exempt from the rule without having to meet all of the requirements for an exemption. Click here for more information and a copy of the final rule.

    Nutter Notes: A person is a fiduciary to an employee benefit plan or an IRA under ERISA and the Code to the extent that the person engages in specified plan activities, including rendering “investment advice for a fee or other compensation, direct or indirect, with respect to any moneys or other property of such plan . . . [.]” The DOL issued regulations in 1975 that narrowed the breadth of the statutory definition of fiduciary investment advice by creating a five-part test that must, in each instance, be satisfied before a person can be treated as a fiduciary. The new definition of a fiduciary will replace that five-part test but will not provide a bright line differentiating between a referral that does not rise to the level of a recommendation constituting investment advice and conduct that does constitute investment advice. The new fiduciary rule includes provisions that will generally allow bank arrangements for the referral of non-deposit investment products in connection with traditional third-party networking arrangements to proceed without causing the bank to be considered a fiduciary. Specifically, such referrals generally will not constitute fiduciary investment advice because they will not constitute a “recommendation” within the meaning of the rule. However, there may be other circumstances in which it may be difficult to determine whether a bank’s activities may constitute advice under the new fiduciary rule in situations where bank customers are requesting information on bank deposit products (such as certificates of deposit) for possible investment in an IRA or other retirement account. Whether a recommendation occurs in any particular instance would be a determination based on facts and circumstances according to the DOL.

5. Other Developments: Assessments, Loan File Reviews and Deposit Insurance Applications 

  • FDIC Modifies How Established Small Banks are Assessed for Deposit Insurance

The FDIC approved a final rule on April 26 that modifies the way banks with less than $10 billion in assets and that have been FDIC insured for at least five years are assessed for deposit insurance. The final rule will be used to determine assessment rates for established small banks beginning the quarter after the Deposit Insurance Fund reserve ratio reaches 1.15 percent, but no earlier than the third quarter of this year.

    Nutter Notes: The final rule adds two new measures to the assessment method—the loan mix index and an asset growth measure. The FDIC expects that the final rule will be revenue neutral, with some banks subject to somewhat higher assessment rates and others somewhat lower rates. The FDIC has revised its online assessment calculator to allow banks to estimate their assessment rates under the final rule. Click here to go to the FDIC’s online assessment calculator. 

  • Federal Reserve Announces Program for Off-Site Loan File Reviews

The Federal Reserve announced on April 19 that state member banks with less than $50 billion in total assets may have Federal Reserve examiners review loan files off-site during full-scope or target examinations. According to Supervision and Regulation Letter no. SR 16-8, Federal Reserve examiners may conduct an off-site loan review if a state member bank agrees and can send legible and sufficiently comprehensive loan information to the Federal Reserve in a secure manner.

    Nutter Notes: State member banks should expect Federal Reserve Banks to ask prior to conducting an examination whether the bank would like to participate in the off-site loan review program. Interested banks should be prepared to demonstrate their ability to appropriately image and send loan documents to the Federal Reserve Bank in a secure manner according to the letter. Click here for a copy of the supervision and regulation letter. 

  • FDIC Issues New Guidance for De Novo Bank Deposit Insurance Applications

The FDIC has issued guidance in the form of supplemental questions and answers (“Q&As”) to help applicants in developing proposals for deposit insurance. The Q&As issued as FDIC Financial Institution Letter no. FIL-24-2016 address business plan content with respect to initial submissions, weaknesses identified in submitted plans, and changes in business plans.

    Nutter Notes: The Q&As supplement the guidance to deposit insurance applicants issued on November 20, 2014 through Financial Institution Letter no. FIL-56-2014. The 2014 guidance addressed pre-filing meetings, processing timelines, initial capitalization and initial business plans of de novo banks. Click here for a copy of the new Q&As.

Nutter Bank Report

Nutter Bank Report is a monthly electronic publication of the Banking and Financial Services Group of the law firm of Nutter McClennen & Fish LLP. Chambers and Partners, the international law firm rating service, after interviewing our clients and our peers in the profession, has ranked Nutter’s Banking and Financial Services practice among the top banking practices in the nation. Visit the U.S. rankings at The Nutter Bank Report is edited by Matthew D. Hanaghan. Assistance in the preparation of this issue was provided by Bridget L. Vellucci. The information in this publication is not legal advice. For further information, contact:

Kenneth F. Ehrlich
Tel: (617) 439-2989

Michael K. Krebs
Tel: (617) 439-2288

This update is for information purposes only and should not be construed as legal advice on any specific facts or circumstances. Under the rules of the Supreme Judicial Court of Massachusetts, this material may be considered as advertising.

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