Why is this Topic Important to Wealth Managers? This topic discusses one of the current trends in the financial services industry of adding additional regulation after the events of the financial crisis. The SEC, along with other agencies, is discussing rules that could have an effect on broker-dealers as well as those companies that employ them. Wealth managers associated with firms involved with the prosed rulemaking should take note.
The SEC recently considered a proposal that would prohibit incentive-based compensation practices that may encourage inappropriate risk.
The proposal arises from Section 956 of the Dodd-Frank Act , which requires the SEC along with six other financial regulators to jointly adopt regulations or guidelines governing the incentive-based compensation arrangements of certain financial institutions. These institutions include broker-dealers and investment advisers with $1 billion or more of assets.
In particular, the Dodd-Frank Act calls upon the regulators to do two things:
First, it calls upon the regulators to adopt rules or guidelines that require these financial institutions to disclose the structure of their incentive-based compensation practices so that the regulator can determine whether such compensation is excessive or whether it could lead to material financial loss to the firm.
Second, the Act calls upon the regulators to adopt rules or guidelines that prohibit these financial institutions from offering any incentive-based compensation arrangement that the regulators determine encourages inappropriate risks – either because the compensation is excessive or because it could lead to material financial loss.
Among other things, the rules considered by the SEC would:
(1) Require reports related to incentive-based compensation that the financial institutions would file annually with the Commission.
(2) Prohibit incentive-based compensation arrangements at financial institutions that encourage inappropriate risk taking by providing excessive compensation or that could lead to material financial loss to the firm.
(3) Provide additional requirements for financial institutions with $50 billion or more in assets, including the deferral of the incentive-based compensation of executive officers and the approval of the compensation of those persons within a firm whose job functions give them the ability to expose the firm to a substantial amount of risk.
(4) Require the financial institutions to develop policies and procedures to ensure and monitor compliance with the requirements related to incentive-based compensation. 
Some in the industry are concerned that the proposal, if adopted, would lead individuals at covered broker-dealers and investment advisers to become unduly conservative and avoid taking even prudent risks. That prospect is troubling; for while it is appropriate to recognize the potential for excessive risk taking, the rule makers also noted that fact that they must recognize that firms can take too few risks. A regulatory regime that places undue emphasis on reducing the likelihood of bad outcomes is costly if it leads to excessive conservatism. Generally speaking, it is usually the case that for an innovative private sector to spurs economic growth depends on the willingness of enterprises to take risks.
What would been a challenging task given the tricky statutory language was reportedly made even more challenging because the joint rulemaking, which has required the agencies to coordinate, deliberate and negotiate with seven total financial regulators. 
For more coverage on the Dodd-Frank Act, see Advisorfyi: New Dodd-Frank Study Calls for Stringent Standards
Tomorrow’s blogticle will present discussion on planning tips.
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 See Chairman Mary L. Schapiro Opening Statement — SEC Open Meeting: Proposed Rules on Incentive-Based Compensation. U.S. Securities and Exchange Commission. March 2, 2011. http://sec.gov/news/speech/2011/spch030211mls-icomp.htm. Last Accessed March 8, 2011.
 See Commissioner Kathleen L. Casey. Commissioner: Statement Regarding Incentive-Based Compensation Rules Pursuant to Section 956 of Dodd-Frank. U.S. Securities and Exchange Commission. March 2, 2011. http://sec.gov/news/speech/2011/spch030211klc-icomp.htm. Last Accessed March 8, 2011.