As published in Bank DirectoR - November 2011

Compensation & Risk - The Directors' Responsibility

By Laura Hay & Susan O'Donnell

New regulations have expanded directors' fiduciary responsibility to evaluate, monitor and disclose the inherent level of risk created by the use of incentive-based compensation programs.  The focus is on employees or groups of employees who are in a position to jeopardize the institution's financial stability.

This white paper outlines specific compensation-related risk requirements under new regulations, including Dodd-Frank, based on financial institutions' type and size; whether they are participating in TARP; ownership structure; and other considerations. It then discusses the identification of covered employees and the areas of risk assessment for which Directors are responsible.

The authors also provide guidance for how Directors can recognize practices and design features that can exacerbate or mitigate risk,  including aspects of compensation that previously were believed to involve reasonable risk but - in the current environment - are regarded as problematical.

The article concludes with a recommended list of questions that Directors can ask as part of the Board's process for compensation risk oversight.