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Client Alert: Don't Forget the Behavioral Impact of Product Incentive Plans

Recent headlines not positive for incentive compensation, but focus is not new.

Incentive compensation "gone bad" is the headline maker these days, but it is fair to say that incentive compensation has been on the bank regulators' minds since the start of the financial crisis. Starting with the 2009 proposed guidelines on sound incentive compensation policies, various bank regulators and other regulatory agencies have come forward with proposed or final rules relating to incentive compensation. The trend continued when, earlier in 2016, various regulators cooperated to release proposed rules to implement restrictions on incentive-based compensation required by the Dodd-Frank Act. While the rules differ based on an institution's size, there are concepts within for all institutions to consider. For an overview of the proposed rules, see our May 2, 2016 Client Alert.

Changing How You Look at Your Incentive Plans

Banks need to look-back at plans and judge the effect on employee behavior to assure employees do not act illegally or inappropriately to receive a larger award.

Incentive plans, themselves, are not bad; but, unchecked they might promote the wrong kind of behavior. Regardless of a bank's asset size, the mistake many banks make in designing and implementing product sales and cross-marketing incentive plans is to ignore the impact the plans are having on employee behavior. Reviewing risk on paper is one step in the process, but banks need to also review the outcomes associated with their incentive plans.
When banks implement referral programs and cross-marketing programs that stretch across the entire organization (e.g., across a bank and its affiliates, even including third party broker-dealers, insurance agencies, investment advisers, real estate agents and mortgage brokers), they need to ensure that they fully understand the behaviors being taken by employees to meet goals under those plans. The complexity and breadth of such plans can make this process even more difficult.

What You Should Consider

Behaviors encouraged by incentive compensation plans must be considered and regulators will want to see plans being moved toward "balance."

All of this means you must evaluate the results of an incentive plan historically to determine their impact. For instance, ask whether there are significant incidences of cancelled or replaced products on which credit should not have been awarded. Also, consider whether the implementation of an incentive plan has coincided with a higher number of such cancellations or replacements or customer complaints. The regulators refer to this as "balancing" the plan and assert that an unbalanced arrangement can be moved toward balance by adding or modifying features that cause the amounts ultimately received by employees to appropriately reflect risk and risk outcomes.

Ability to decrease or defer incentives should be built into the plan.

Regulators have long signaled that bank compensation programs should reduce remuneration to employees whose accounts show missing documents, unreported customer complaints, reversed or "bad" sales, and compliance problems. This theme plays out throughout the guidance issued over the last few years. Banks should consider whether a mandatory deferral feature would give them more time to review the behaviors being incentivized and their consequences. To be most effective, regulators suggest that a deferral period should be sufficiently long to allow for the realization of a substantial portion of the risks from employee activities.

A Helpful Illustration

A joint enforcement action between the CFPB and the FDIC against Discover Bank in 2012 provides a helpful illustration of how the agencies might expect organizations to address the look-back and deferral. This action targeted the marketing and sales of some of Discover's credit card add-on products. As a result of the action, Discover was required to make restitution, pay penalties and adopt certain remedial measures with respect to its incentive programs including the adoption of a policy providing that any incentive compensation based directly on the sale of one of the products would not be payable unless the customer remained enrolled in the product for at least three billing cycles.

Deferrals and monitoring behavioral impact – it's a start when attempting to read between the lines of all the regulatory guidance, proposed rules, enforcements actions and remedial requirements and how they apply to product sales and cross-selling arrangements.
Want more information on incentive compensation? We have posted the following Client Alerts on our website that provide the background and context for the new rules:


We Can Help You

Please contact any of the key contacts listed below or another member of the Firm, if you have any questions or would like additional information regarding the issues above.

    Client Alert - Don't Forget the Behavioral Impact of Product Incentive Plans.pdf

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