Update on Executive Compensation for Global Financial Services Companies

This presentation has been provided for informational purposes only and is not intended and should not be construed to constitute legal advice. Please consult your attorneys in connection with any fact-specific situation under federal, state, and/or local laws that may impose additional obligations on you and your company. WebEx can be used to record webinars/briefings. By participating in this webinar/briefing, you agree that your communications may be monitored or recorded at any time during the webinar/briefing. Attorney Advertising 2014 Epstein Becker & Green, P.C. All Rights Reserved. ebglaw.com 2

Presented by Gretchen Harders Epstein Becker Green, Employee Benefits Practice gharders@ebglaw.com 212.351.3784 Erin Miner Credit Suisse, Counsel erin.miner@credit-suisse.com 212.325.1037 2014 Epstein Becker & Green, P.C. All Rights Reserved. ebglaw.com 3

Agenda 1. European Executive Compensation Initiatives and Regulations 2. Status of U.S. Regulation of Executive Compensation 3. Dodd-Frank Developments in Deferred Compensation 4. Executive Compensation and the Volcker Rule 5. Banking Regulations and Audit Guidelines 6. Clawback Strategies and Enforcement 2014 Epstein Becker & Green, P.C. All Rights Reserved. ebglaw.com 4

European Executive Compensation Initiatives and Regulations European Executive Compensation Initiatives and Regulations Financial service sector regulations Broader initiatives 2014 Epstein Becker & Green, P.C. All Rights Reserved. ebglaw.com 6

European Executive Compensation Initiatives and Regulations Many active stakeholders having a voice: The shareholders The media The politicians! The regulators The customers The employees 2014 Epstein Becker & Green, P.C. All Rights Reserved. ebglaw.com 7

HSBC shareholders protest over pay in 2014: A fifth of shareholders have failed to support HSBC s remuneration policy, which the company had already revised to try and avoid a revolt 2014 Epstein Becker & Green, P.C. All Rights Reserved. ebglaw.com 8

European Executive Compensation: Financial Services Remuneration Regulations Where it started: FSB Principles for Sound Compensation Practices 2009 http://www.financialstabilityboard.org/activities/ compensation/ EU Capital Requirements Directive III (CRD 3) Governance process Deferral Use of equity Identify risk takers Risk adjustment (malus) 2014 Epstein Becker & Green, P.C. All Rights Reserved. ebglaw.com 9

Major Changes For 2014-2015 EU CRD IV Bonus cap: 1x fixed (2x with shareholder approval) Use capital instruments (bail-in bonds/cocos) All variable subject to malus and clawback Identification of Material Risk Takers Maintenance of a website on corporate governance and remuneration A number of Binding Technical Standards and EBA guidelines to provide detailed requirements 2014 Epstein Becker & Green, P.C. All Rights Reserved. ebglaw.com 10

EU EBA Binding Technical Standards Material Risk Takers (effective June 2014) Objective is to set out both qualitative and quantitative criteria to identify Covered/Identified/Code Staff. Key change was to require anyone earning 500k total comp to be a MRT, have to apply to disapply. Classes of Instrument Suitable For Variable Comp (effective Sept 2014) Sets out additional instruments. The BTS will be part of single rule book aimed at enhancing regulatory harmonisation in EU. Guidance is still awaited on whether other instruments must be used to comply with CRD IV. 2014 Epstein Becker & Green, P.C. All Rights Reserved. ebglaw.com 11

EU EBA 2014 Guidelines on Discount Rate for Variable Remuneration (effective 27 May 2014) CRDIV allows a discount factor to be applied in calculating bonus cap ratio for awards vesting 5years+ EBA Single Rulebook Q&A About Remuneration (Sept 2014) EBA Guidelines on Remuneration Benchmarking (effective 31 Oct 2014), required by CRR Addresses calculation of remuneration, secondment contracts, scope of institutions subject to data collection, consolidation of information Increases consistency of info collected on remuneration practices in order to benchmark trends EBA Guidelines on Data Collection Exercise for High Earners (effective 31 Oct 2014) Increases consistency of info on number of individuals in pay brackets over 1m 2014 Epstein Becker & Green, P.C. All Rights Reserved. ebglaw.com 12

EU - EBA Opinion on Fixed Allowances (Oct 2014) Identified criteria on what it thinks is fixed and what is not Await Updated EBA Guidance Expected During Q4 2014 or Q1 2015 Issues likely to be covered: Characteristics of fixed remuneration Use of other instruments Possibly application of proportionality Clawbacks 2014 Epstein Becker & Green, P.C. All Rights Reserved. ebglaw.com 13

Basel Corporate Governance Revised corporate governance principles for banks (Oct 2014) Consultation paper seeking to revise its principles. Key proposals: Further guidance on risk governance, Guidance on the role of the board, Recognises importance the incentives structure conveys acceptable risktaking behaviour. Consultation period ends 9 Jan 2015 2014 Epstein Becker & Green, P.C. All Rights Reserved. ebglaw.com 14

UK PRA: Clawback Introduced From 1 Jan 15 (PS7/14) PRA Consultation: Implementing UK PCBS strengthening the alignment of risk and reward (PC15/14) PRA: Consultation on Senior Manager Regime (CP14/14) PRA: Templates for Reporting (issued Nov 2014) All variable pay, including immediately paid cash bonuses to be subject to clawback for up to 7 years Potential further changes to: Increasing length of deferral Length of clawback Buyouts (unlikely anything will changes Remuneration of Non-Executive Directors The proposed changes are significant and include: SMR will be subject to regulatory approval A certification regime which will require firms to assess fitness of certain employees Expected new templates for setting out RPS and disclosing use of malus and clawback. These are not publically disclosed 2014 Epstein Becker & Green, P.C. All Rights Reserved. ebglaw.com 15

Status of U.S. Regulation of Executive Compensation Executive compensation heavily regulated Federal laws State Laws Financial Industry Regulatory Authority (FINRA) 2014 Epstein Becker & Green, P.C. All Rights Reserved. ebglaw.com 17

Federal Laws: Overview Dodd-Frank Sarbanes-Oxley Internal Revenue Code (the Code) Employee Retirement Income Security Act (ERISA) Securities Exchange Act 2014 Epstein Becker & Green, P.C. All Rights Reserved. ebglaw.com 18

Laws of Individual States State tax law: Laws of the state where the money is earned Laws of the state where the taxpayer resides State contract law: Employment agreements setting the terms of executive compensation generally governed by state contract law State wage laws: Prohibition of forfeiture of wages 2014 Epstein Becker & Green, P.C. All Rights Reserved. ebglaw.com 19

FINRA Authority to levy fines and discipline brokers and firms Also refers cases to federal enforcement authorities such as the SEC and DOJ Has exclusive jurisdiction over many financial industry contract disputes including disputes over executive compensation In January 2012, FINRA levied a $1 million fine against a firm for litigating a dispute over executive compensation in New York state court rather than through a FINRA arbitration 2014 Epstein Becker & Green, P.C. All Rights Reserved. ebglaw.com 20

Hot Topic: Employee Loans Structuring a portion of executive compensation in the form of a loan to an employee Only bona fide loans receive favorable tax treatment Loans with interest rates below fair market value are taxed under Section 7872 of the Code The loan must require cash payments in accordance with a specific repayment schedule The loan cannot be structured in a manner such that it will be forgiven upon a term of service with the employer It is difficult and expensive to collect delinquent loan payments 2014 Epstein Becker & Green, P.C. All Rights Reserved. ebglaw.com 21

Hot Topic: Retirement Provisions and ERISA Defines pension plan as deferral of income to termination of employment or beyond Facts and circumstances test Top hat plan exemption How long is the bonus deferred? 2014 Epstein Becker & Green, P.C. All Rights Reserved. ebglaw.com 22

Dodd-Frank Developments in Deferred Compensation One of the principal elements of the Dodd-Frank Wall Street Reform and Consumer Protection Act ( Dodd-Frank ) is the regulation of executive compensation These regulations are designed to cause executive compensation packages to: Disincentivize excessive risk taking Reward strategies focused on long term growth 2014 Epstein Becker & Green, P.C. All Rights Reserved. ebglaw.com 24

Dodd-Frank: Regulation of Financial Institutions Section 956 of Dodd-Frank prohibits incentive-based payment arrangements at a covered financial institution that encourage inappropriate risks by providing excessive compensation or that could lead to a material financial loss Covered financial institutions are financial institutions with assets exceeding $1 billion Different regulatory agencies, FDIC, SEC, Federal Reserve, Office of Comptroller of Currency, Office of Thrift Supervisions Treasury, National Credit Union Administration, and the Federal Housing Finance Agency Brokers and asset managers 2014 Epstein Becker & Green, P.C. All Rights Reserved. ebglaw.com 25

Dodd-Frank: Foreign Banking Organizations (FBOs) Assets in excess of $10 billion Will they look at US held assets or global assets? Who are the directors and officers? How will these rules align with foreign jurisdiction requirements 2014 Epstein Becker & Green, P.C. All Rights Reserved. ebglaw.com 26

Dodd-Frank: Institutional Regulations Performance criteria and appropriate benchmarks Short and long-term incentives Hold to retirement Sales of derivatives Involvement of appropriate risk and compliance personnel Consistency across covered financial institution Competition for talent / hedge funds 2014 Epstein Becker & Green, P.C. All Rights Reserved. ebglaw.com 27

Dodd-Frank: Mandatory Deferred Incentive Compensation A proportion of incentive compensation must be deferred at least 3 years Must defer at least 50% for executive officers Must defer at least 30% for ordinary employees 2014 Epstein Becker & Green, P.C. All Rights Reserved. ebglaw.com 28

Dodd-Frank: Limits on Excessive Risk-taking How to assess unnecessary risk taking? Risk/compliance departments should be independent Legal review at front end of the development of incentive compensation plans 2014 Epstein Becker & Green, P.C. All Rights Reserved. ebglaw.com 29

Dodd-Frank: Interaction with Other Federal Laws Preemption and the extent to which Dodd-Frank preempts other requirements, e.g., ERISA, state law What happens in the event of bankruptcy / insolvency Dodd-Frank issued proposed rules on recovery of executive compensation in the event of bankruptcy or insolvency of a financial institution Definition of control 2014 Epstein Becker & Green, P.C. All Rights Reserved. ebglaw.com 30

Executive Compensation and the Volcker Rule The Volcker Rule prohibits banks from engaging in proprietary trading for their own benefit There is an exception for certain underwriting and market-making activities The regulations prohibit compensation arrangements designed to reward or incentivize prohibited proprietary trading 2014 Epstein Becker & Green, P.C. All Rights Reserved. ebglaw.com 32

Volcker Rule: Examples of Permitted and Prohibited Compensation Permitted compensation structures Compensation incentives that primarily reward customer revenues and effective customer service Prohibited compensation structures Compensation incentives which rewards speculation in, and appreciation of, the market value of a position held in inventory Compensation plans based purely on net profit and loss with no consideration for inventory control or risk undertaken to achieve those profits 2014 Epstein Becker & Green, P.C. All Rights Reserved. ebglaw.com 33

Banking Regulations and Audit Guidelines The Office of the Comptroller of the Currency (OCC) Proposed Rules and Guidelines for Risk Management Governance Applies to U.S. banks and insured U.S. branches of foreign banks with total consolidated assets of $50 billion or more but may be extended to banks with fewer assets if the OCC determines such entity s operations are highly complex or otherwise present a heightened risk as to require compliance with the Guidelines Contains similar expectations for bank governance as those of the Basel Committee on Banking Supervision General goal is for banks to implement a framework to oversee and monitor investment risk with a separate reporting and incentive structure 2014 Epstein Becker & Green, P.C. All Rights Reserved. ebglaw.com 35

OCC Proposals Relating to Executive Compensation Ensure that compensation packages do not incentivize excessive risk taking Compensation of risk management personnel should be such that employers can attract and retain the talent needed to design, implement, and maintain an effective risk governance framework This includes hiring Chief Risk Executives and Chief Audit Executives who report directly to the board of directors or a board committee Ensure that front line unit compensation plans and decisions appropriately consider the level and severity of issues and concerns identified by independent risk management and internal audit 2014 Epstein Becker & Green, P.C. All Rights Reserved. ebglaw.com 36

External Audits: Minimizing Scope External and government audits are generally conducted for a specific purpose Control the auditor s access to information to ensure the auditors are focusing on documents relevant to the purpose of the audit 2014 Epstein Becker & Green, P.C. All Rights Reserved. ebglaw.com 37

Clawback Strategies and Enforcement CRD IV: Requires variable pay to be subject to adjustment. Up to 100 % of the total variable remuneration shall be subject to malus or clawback arrangements. Institutions shall set specific criteria for the application of malus and clawback. Such criteria shall in particular cover situations where the staff member: (i) participated in or was responsible for conduct which resulted in significant losses to the institution; (ii) failed to meet appropriate standards of fitness and Propriety Art 94 (n) 2014 Epstein Becker & Green, P.C. All Rights Reserved. ebglaw.com 39

UK PRA Remuneration Code A firm must ensure that: any variable remuneration, including a deferred portion, is paid or vests only if it is sustainable according to the financial situation of the firm as a whole, and justified on the basis of the performance of the firm, the business unit and the individual concerned; any variable remuneration is subject to clawback, such that it is not awarded save where an amount corresponding to it can be recovered from the individual by the firm if the recovery is justified on the basis of the circumstances described in SYSC 19A.3.51AR(3) and 19A.3.51B; and variable remuneration is subject to clawback for a period of at least 7 years from the date on which it is awarded. 19A.3.51 R 2014 Epstein Becker & Green, P.C. All Rights Reserved. ebglaw.com 40

PRA Remuneration Code (continued) 19A.3.51A R A firm must: ensure that any of the total variable remuneration is subject to malus or clawback arrangements; set specific criteria for the application of malus and clawback; and ensure that the criteria for the application of malus and clawback in particular cover situations where the employee: (a) participated in or was responsible for conduct which resulted in significant losses to the firm; or (b) failed to meet appropriate standards of fitness and propriety. 19A.3.51B R A firm must make all reasonable efforts to recover an appropriate amount corresponding to some or all vested variable remuneration where either of the following circumstances arise during the period in which clawback applies: (a) there is reasonable evidence of employee misbehaviour or material error; or (b) the firm or the relevant business unit suffers a material failure of risk management. A firm must take into account all relevant factors (including, where the circumstances described in (b) arise, the proximity of the employee to the failure of risk-management in question and the employee s level of responsibility) in deciding whether and to what extent it is reasonable to seek recovery of any or all of their vested variable remuneration 2014 Epstein Becker & Green, P.C. All Rights Reserved. ebglaw.com 41

Strategies for Developing Clawback Policy Who is in scope? What is in scope? What are the triggers? Level 1 and 2 firms MRT Consider including others? All variable remuneration These are set out in earlier slide When should clawback apply? Remuneration awarded after 1 Jan 2015 PRA expect 2014 bonuses to be covered. AFME/BBA have challenged this. 2014 Epstein Becker & Green, P.C. All Rights Reserved. ebglaw.com 42

Strategies for Developing Clawback Policy What amount is covered by clawback? Regulations refer to recovering appropriate amount Most are drafting up to gross amount and will decide at time of operation how much is appropriate What efforts must be taken to enforce clawback? Regulations refer to reasonable efforts This will depend on amount and likelihood of recovery as well as the contractual incorporation of the clawback terms 2014 Epstein Becker & Green, P.C. All Rights Reserved. ebglaw.com 43

Strategies for Developing Clawback Policy Key legal considerations which come up are: Penalty/liquidated damages Restraint of trade Minimum wage issues! Unlawful deductions These types of issues need to be considered in any country in which clawback may be imposed 2014 Epstein Becker & Green, P.C. All Rights Reserved. ebglaw.com 44

Strategies for Developing Clawback Policy Implementing clawback: What communications will staff have? When? Will they be asked to confirm acceptance? If so when? This all goes to likely enforceability of clawback 2014 Epstein Becker & Green, P.C. All Rights Reserved. ebglaw.com 45

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