May31,2011 Ms.ElizabethMurphy Secretary U.S.SecuritiesandExchangeCommission 100FStreet,N.E. Washington,D.C.205491090 Re: IncentiveBasedCompensationArrangements(FileNumberS71211) DearMs.Murphy: TheInvestmentCompanyInstitute1appreciatestheopportunitytocommentontheSecurities andExchangeCommissionsproposedrulesonincentivebasedcompensation.2Theseruleswere mandatedbySection956oftheDoddFrankWallStreetReformandConsumerProtectionAct (DoddFrank).3 ThisrulemakingpresentstheAgencieswithadistinctchallenge.AstheReleasenotes, compensationarrangementsarecriticaltoolsinthesuccessfulmanagementoffinancialinstitutions.

ions. TheAgenciesmusttakegreatcaretocraftrulesthattaketwo,sometimesopposing,approaches:the rulesshouldbeprinciplesbasedandflexibleenoughtoallowfirmstotailortheircompensation practicesandcompeteinthemarketfortalent,butmustalsoprovidecoveredfirmswithenoughclarity

1

TheInvestmentCompanyInstituteisthenationalassociationofU.S.investmentcompanies,includingmutualfunds, closedendfunds,exchangetradedfunds(ETFs),andunitinvestmenttrusts(UITs).ICIseekstoencourageadherenceto highethicalstandards,promotepublicunderstanding,andotherwiseadvancetheinterestsoffunds,theirshareholders, directors,andadvisers.MembersofICImanagetotalassetsof$13.1trillionandserveover90millionshareholders.

IncentivebasedCompensationArrangements,ReleaseNo.3464140(March29,2011),76Fed.Reg.21170(April14,2011) (theRelease),availableathttp://www.sec.gov/rules/proposed/2011/3464140.pdf.
3

Section956requirestheSEC,aswellastheOCC,BoardofGovernorsoftheFederalReserveSystem,FDIC,OTS, NCUA,andFHFA(togethertheAgencies)tojointlyprescriberegulationsorguidelineswithrespecttoincentivebased compensationpracticesatcoveredfinancialinstitutions.Specifically,Section956requiresthattheAgenciesprohibit incentivebasedpaymentarrangements,oranyfeatureofanysucharrangement,atacoveredfinancialinstitutionthatthe Agenciesdetermineencouragesinappropriaterisksbyafinancialinstitutionbyprovidingexcessivecompensationorthat couldleadtomaterialfinancialloss.Section956alsorequirescoveredfinancialinstitutionstosubmitreportstothe appropriateAgencydescribingthestructureoftheirincentivebasedcompensationarrangementssufficienttoallowthe Agencytodeterminewhetherthearrangementsprovideexcessivecompensation,fees,orbenefitsorcouldleadtomaterial financiallosstotheinstitution.

 Ms.ElizabethMurphy May31,2011 Page2of9 thattheycandesigncompensationpracticesthatarefullylegalandcompliant. WeappreciatetheAgencieseffortstostriketherightbalancebetweenflexibilityandcertainty intheproposedrules,andwesupporttheprinciplesbasedapproachgenerallytakenbytheAgencies. Overlyprescriptiveruleswouldstiflecompetitionandultimatelyfail.AsCommissionerParedesstated, simplyput,theCommissionisnotwellequippedtoprescriberulesthatdictatethespecificsofhow individualsmustbepaid.4 Nevertheless,wehaveseveralconcernswiththeproposal: Thestandardsforprohibitedconductarenotclear.Toimprovethatclaritywithout takinganoverlyprescriptiveapproach,werecommendincludingarebuttable presumptioninthefinalrulesthatcompensationarrangementsapprovedingoodfaith byacoveredfinancialinstitutionsboardarepermissible.Wealsorecommendthatthe Commissionsstaff,separatelyfromtheotherAgencies,providesupplementaryFAQs thatillustratethetypesofarrangementsorpracticesthatithasidentifiedas inappropriate,excessive,unreasonable,ordisproportionate. Thereisverylittle,ifany,meaningfuldiscussionintheReleaseaboutthedistinction betweenappropriaterisksandinappropriaterisks.Whilewebelievethatthe Agenciesshouldavoidprescriptivestatementsaboutpreciselywhatrisksmaybe inappropriate,theAgenciesshouldmakeitveryclearthatthereisadistinctionbetween takingriskswiththefirmsownassetsandtakingfullydisclosedinvestmentriskwith clientassets.Thelatterisquitesimplynotthebehaviorthatthisruleismeantto address. Anoveremphasisoncomparatorsindeterminingtheexcessivenessofcompensation couldquelllegitimatecompetitionfortalent.Althoughcomparatorsareclearly relevant,theAgenciesshouldexpresslystatethatafirmpositioningitselfatthetopof thecompensationspectrumdoesnot,byvirtueofthatfactalone,provideexcessive compensation.Somefirmschoosetoholdthemselvesoutasprovidingbetter compensationpackagesthantheircompetitors,andnothinginSection956orthis rulemakingshouldprohibitthemfromcompetingfortalentinthemarketplaceonthat basis. StatementsintheReleaseabouttheAgenciesexpectationsforriskmanagementand
4

StatementatOpenMeetingtoProposeRulesRegardingIncentiveBasedCompensationArrangements,CommissionerTroyA. Paredes(March2,2011),avail.athttp://www.sec.gov/news/speech/2011/spch030211tapicomp.htm.

 Ms.ElizabethMurphy May31,2011 Page3of9 internalcontrolpersonnelareoverlyprescriptive.Whilemanyfirmsmayuserisk managementandinternalcontrolpersonnelinmuchthewaysuggestedbytheRelease, othersmaynot.TheAgenciesneednot,andshouldnot,micromanagetheprocessto thelevelsuggestedintheRelease.Rather,eachfirmshouldbeaffordedtheflexibilityto determinethebestwaytoutilizeitsstafftoachievetheAgenciesgoalson compensation. Whilewestronglysupporttheuseofabalancesheetassetstestfordeterminingstatus asacoveredfinancialinstitution,thedefinitioncouldbeimprovedinseveral respects.Thefinalrulesshouldclarifythestatusofbankandthriftsubsidiariesand impartsomeflexibilityforfirmsthattemporarilymaycrossthe$1billionor$50billion thresholds. Separatestandardsforlargerfirmsarenotwarrantedatthistime.Nothingin Section956suggestsadifferentstandardforlargerfirms,andnothingrequiresthe Agenciestoproposeexplicitrequirementsonthedeferralofexecutivecompensation. WerecommendthattheAgenciesreconsidertheproposedrequirementsforlarger coveredfinancialinstitutions,andadoptthemonlyafterexperiencewiththerule demonstratesthatthegeneralrequirementsarenotsufficienttodealwithincentive compensationpracticesatthosefirms. Theseconcernsandrecommendationsareexplainedmorefullybelow. 1. StandardsforProhibitedConduct Despiteourstrongsupportforaflexible,principlesbasedapproach,weareconcernedthatparts oftheproposal,includingthetwomainprohibitions,aresovagueastoprovidenopracticalguidanceto regulatedentitiesandreservevirtuallyunfettereddiscretiontoregulators.5Standardsmustbeclear, particularlywithrespecttoprohibitedconduct.Normativetermssuchasinappropriate,excessive, unreasonable,anddisproportionateerectinherentlysubjectivestandardsthatareeasyforregulators toapplyposthoctofactsandcircumstances,butarefarharderforregulatedentitiestouseexantein craftingcompliancepoliciesandprocedures.Werecognizethatitmaybedifficulttocraftrulesdefining thesetermswithoutbecomingoverlyprescriptive,buttheAgenciesmustalsorecognizethatsuch vaguenesswillnotpromotethepurposesofthelaworfacilitatecompliance.IftheAgenciesthemselves cannotbetterarticulatetheparametersoftheirrules,howthencantheregulatedcommunity?
Moreover,itisnotclearthatCongressintendedtheAgenciestoadopttheseprohibitionsbymerelyincorporatingthe statutorytext.Section956instructstheAgenciestoprohibitpracticesthattheregulatorsdetermineencourages inappropriaterisks.Bymerelyparrotingthestatutorytext,theAgencieshavemadenosuchdetermination.
5

 Ms.ElizabethMurphy May31,2011 Page4of9 Wehavetworecommendationstomoreclearlydefinetheparametersofprohibitedconduct whilemaintainingtherulesprinciplesbasedapproach.First,therulesshouldcreatearebuttable presumptionthatcompensationarrangementsapprovedingoodfaithbyacoveredfinancial institutionsboardarepermissible.Theproposedrulespecificallyrequiresincentivebased compensationarrangementstobesupportedbystrongcorporategovernance,includingactiveand effectiveoversightbythecoveredfinancialinstitutionsboardofdirectorsoracommitteethereof. Regulatorsshouldnotbepermittedtosecondguesscompensationdecisionsandfindthat compensationisexcessiveorencouragesinappropriateriskunlessthereisclearandcompellingevidence thattheboardhasnotfulfilledthismandate,andhasactedinbadfaithorwithalackofduecarein approvingthecompensation. Second,werecommendthattheCommissionstaff,separatelyfromtheotherAgencies,provide supplementaryguidancethroughinformalFAQsthatillustratesthetypesofarrangementsorpractices thatithasidentifiedasinappropriate,excessive,unreasonable,ordisproportionate.TheRelease specificallycontemplatesthistypeofapproach,asitstatesthat[e]achAgencymayissuesupplemental guidancespecifictotheirregulatedentities,includingguidanceasnecessarytoclarifytheregulatory requirementsproposedinthisrulemaking.6Whileweunderstandthatthestaffmaybehesitantto provideexamplesoutofconcernthattheybeviewedastheexclusivecircumstancesinwhichthe prohibitionsareviolated,itcouldmakeclearthatanyexamplesprovidedareillustrativeonlyandnot meanttoconstituteanexhaustivelistofpracticesthatmayviolatetherules. 2. Appropriatevs.InappropriateRisks Theproposedrulewouldprohibitacoveredfinancialinstitutionfromestablishingor maintaininganyincentivebasedcompensationarrangementthatencouragesinappropriaterisksby thecoveredfinancialinstitutioneitherbyprovidingacoveredpersonwithexcessivecompensationor byprovidingincentivebasedcompensationtocoveredpersonsthatcouldleadtomaterialfinancialloss tothecoveredfinancialinstitution. Thereisverylittle,ifany,meaningfuldiscussionintheReleaseaboutthedistinctionbetween appropriaterisksandinappropriaterisks.Allfinancialinstitutionstakerisks,includingsomethat mayexposethefirmtoamaterialfinancialloss.Andsomefinancialinstitutions,likeinvestment advisers,areengagedspecificallytotakedisclosedinvestmentriskswiththeirclientsassets. Accordingly,itwillbecrucialforthesefirmstobeabletoclearlydistinguishbetweenappropriateand inappropriaterisks.
6

Release,76Fed.Reg.at2117374.

 Ms.ElizabethMurphy May31,2011 Page5of9 WhilewebelievethattheAgenciesshouldavoidprescriptivestatementsaboutpreciselywhat risksmaybeinappropriate,theAgenciesshouldmakeitveryclearthatthereisadistinctionbetween takingriskswiththefirmsownassetsandtakingfullydisclosedinvestmentriskwithclientassets.The latterisquitesimplynotthebehaviorthatthisruleismeanttoaddress.Rather,itisbehaviorthatis fullydisclosed,heavilyregulated,andbothexpectedanddemandedbytheclient. TheUKsFinancialServicesAgency(FSA)recentlyrecognizedthispointincraftingits remunerationrules,applyingdifferentminimumexpectationsforcompliancetofirmsbasedontheir tier.Thehighesttiersappliedtocreditinstitutionsandbrokerdealersthatengageinsignificant proprietarytradingand/orinvestmentbankingactivities.Thelowesttier,tierfour,containsfirms,like assetmanagers,thatgenerateincomefromagencybusinesswithoutputtingtheirbalancesheetsatrisk.7 TheFSAsrulesrecognizethataninvestmentadvisorybusinessisquitedifferentthanabanksor brokerdealersbusiness,andinvolvesalowerenterpriseriskthatshouldbereflectedinaremuneration rule.TheAgenciesshouldfollowsuitandcraftarulethattakesfullaccountoftheverydifferentrisk characteristicsoftheaffectedbusinesses.Ajointrulemakingdoesnotjustifyanacrosstheboard approach. 3. TheStandardsforExcessiveCompensation TheproposedrulesetsforthsevenconsiderationstheAgencieswilltakeintoaccountwhen determiningwhetheraparticulararrangementprovidesexcessivecompensation.Theseinclude variouscomparativemetrics,likethecompensationhistoryofotherindividualswithcomparable expertiseatthecoveredfinancialinstitution,andcomparablecompensationpracticesatfirmswith comparablesize,geographiclocation,andcomplexity. Althoughsuchcomparatorsareclearlyrelevant,theAgenciesshouldexpresslystatethatafirm positioningitselfatthetopofthecompensationspectrumdoesnot,byvirtueofthatfactalone,provide excessivecompensation.Somefirmschoosetoholdthemselvesoutasprovidingbettercompensation packagesthantheircompetitors,andnothinginSection956orthisrulemakingshouldprohibitthem fromcompetingfortalentinthemarketplaceonthatbasis.Anoveremphasisoncomparatorsin determiningtheexcessivenessofcompensationcouldquelllegitimatecompetitionfortalent. 4. CompatibilitywithEffectiveControlsandRiskManagement Asnotedabove,theproposedrulewouldprohibitacoveredfinancialinstitutionfrom establishingormaintaininganyincentivebasedcompensationarrangementthatencourages inappropriaterisksthatcouldleadtomaterialfinanciallosstothecoveredfinancialinstitution.
7

SeeRevisingtheRemunerationCode,FSAPolicyStatement10/20(Dec.2010),atpages3237.

 Ms.ElizabethMurphy May31,2011 Page6of9 Inordertoavoidviolatingthisprohibition,theproposedruleexpresslystatesthatthe compensationarrangementmustbebalanced,compatiblewitheffectivecontrolsandrisk management,andsupportedbystrongcorporategovernance.Theproposedrulesalsorequirepolicies andprocedurestoensurethatriskmanagement,riskoversight,andinternalcontrolpersonnelhavean appropriateroleinthecoveredfinancialinstitutionsprocessesfordesigningincentivebased compensationarrangementsandforassessingtheireffectivenessinrestraininginappropriaterisk taking. Inexplainingwhatismeantbythoseprovisions,theAgencieslayouttheirexpectationsforrisk managementandinternalcontrolpersonnel: [T]heAgenciesbelievethatriskmanagement,riskoversight,and internalcontrolpersonnelshouldbeinvolvedinallphasesofthe processfordesigningincentivebasedcompensationarrangements. Riskmanagementandriskoversightpersonnelalsoshouldhave responsibilityforongoingassessmentofincentivebasedcompensation policiestohelptoensurethatthecoveredfinancialinstitutions processesremainuptodateandeffectiverelativetoitsincentive compensationpractices.8 Whileitmaybeagoodideaforafirmtoconsidertheappropriateroleofriskmanagementand internalcontrolpersonnelinthedesignandimplementationofthefirmscompensationarrangements, itisnotappropriatefortheAgenciestosoexpresslydictatetherolesandresponsibilitiesofspecific personnel.Whilemanyfirmsmayuseriskmanagementandinternalcontrolpersonnelinmuchtheway suggestedbytheRelease,othersmaynot.Someadvisersmayhaveriskmanagementpersonnelfocus solelyoninvestmentrisk,andthedesignofcompensationarrangementsmaybewelloutsidetheirarea ofexpertise.Somefirmsmayuseinternalcontrolpersonneltactically,ratherthanstrategically.There maynotbearoleforthemtoplayindesigningacompensationplan.Moreover,complianceandcontrol personnelaremosteffectivewhentherulesareclear,which,asnotedabove,isnotthecasehere. Forallofthesereasons,webelievethateachfirmshouldbeaffordedtheflexibilitytodetermine thebestwaytoutilizeitsstafftoachievetheAgenciesgoalsoncompensation.TheAgenciesneednot, andshouldnot,micromanagetheprocesstothelevelsuggestedintheRelease.

Release,76Fed.Reg.at21182.

 Ms.ElizabethMurphy May31,2011 Page7of9 5. DefinitionofCoveredFinancialInstitution InGeneral.EachoftheAgenciesdefinecoveredfinancialinstitutionforpurposesofthe applicationoftheirrules.TheCommissionsdefinitionwithrespecttoinvestmentadvisersisclearand straightforwardthetermincludesaninvestmentadviserassuchtermisdefinedinsection 202(a)(11)oftheInvestmentAdvisersActof1940(15U.S.C.80b2(a)(11))thathastotal consolidatedassetsof$1billionormore.Wesupportthatdefinition.9 StatusofSubsidiaries.ThedefinitionsproposedbytwooftheAgenciestheBoardandthe OTSarenotasclearastheCommissionsdefinition,inthattheyexplicitlyreferencesubsidiaries.As proposed,theBoardsdefinitionexpresslystatesthatacoveredfinancialinstitutionincludesthe subsidiariesoftheinstitution.Similarly,theReleasesuggeststhatinthecaseoftheOTS,acovered financialinstitutionalsoincludesanoperatingsubsidiary,althoughtheOTSruledoesnotincludean expressreferencetosubsidiaries. Giventhesedefinitions,itisunclearhowtherulesapplytobrokerdealersorinvestment adviserssubjecttotheCommissionsjurisdictionthataresubsidiariesofbanksorthrifts.Consider,for example,abankholdingcompanysubjecttotheBoardsjurisdictionwithgreaterthan$50billionin assetsandaninvestmentadvisersubsidiary.AlthoughtheBoardsdefinitionclearlystatesthatthe banksstatusincludestheadviser,doesthatmeanthattheadviserisseparatelyconsideredacovered financialinstitution(andthereforemustsubmitaseparatereporttoitsprimaryregulator,theSEC)?If so,wouldtheinvestmentadviserbeconsideredalargercoveredfinancialinstitutionbecauseitis ownedbyabankthatqualifiesassuch?Doesanypartofthisanalysisturnonwhethertheadviserhas over$1billionintotalconsolidatedassetsonitsbalancesheet?
9

Whileafirmsbalancesheetassetscalculatedundergenerallyacceptedaccountingprinciplesprovideanobjective,readily availablemeasureofafirmssize,weareconcernedthattotalconsolidatedassetsmay,incertaincircumstances,overstatethe sizeofthefirmandtheamountofsystemicriskitpresentstothefinancialsystem.Forexample,aninvestmentadviserthat hasacquiredanotheradviserwilltypicallyrecognizegoodwillasanintangibleasset.Goodwillrepresentstheexcessofthe considerationpaidbytheacquireroverthefairvalueoftheacquiredadvisersidentifiableassets.Whereaninvestment adviserstotalconsolidatedassetsexceedthe$1billionthresholdduetointangibleassetssuchasgoodwill,weareuncertain thatthepurposesofSection956areachievedbydeemingtheadvisertobeacoveredfinancialinstitution.Toprovide flexibilityinthatcontext,andinothersituationswheretheapplicationofthetotalconsolidated assetstestproducesodd results,werecommendthattheAgenciesincorporateamechanismintothefinalrulesthatwouldpermitfirmsinsuch situationstoseekrelief. WealsohaveconcernswithanongoingprojectattheFinancialAccountingStandardsBoardthatmay require an investmentadvisertoconsolidateanyinvestmentcompanyitadvises.SeeFinancialAccounting StandardsBoard, ConsolidationPolicyand Procedures.Inparticular,iftheFASBrequiresinvestmentadviserstoconsolidatethefundsthey advise,adviserstotalconsolidatedassetsmayincreasebyafactoroften,orahundred,ormore,significantlyincreasingthe populationofcovered financial institutions. In such case, the Agencies will need to revisit thetotal consolidated assets test to ensurethat it is working as intended.

 Ms.ElizabethMurphy May31,2011 Page8of9 Webelievethattherulesshouldbestructuredtoapplysolelytothoseentitieswhether parentsorsubsidiariesthatmeetbothoftherelevanttests:theentityisanenumeratedbank,broker dealer,orinvestmentadviser,andtheentity,onitsown,hastherequisiteassets.Anyreferenceto subsidiariesshouldnotinadvertentlysweepinsmallerfirmsthatwouldnot,standingontheirown,be subjecttotherules. Wefurtherbelievethatanycoveredfinancialinstitution(aparentCFI)shouldbepermitted tocomplyonitsownbehalfandonbehalfofanysubsidiarythatisitselfacoveredfinancialinstitution (asubsidiaryCFI)byadoptingproceduresandbymakingreportstotheparentCFIsprimary regulatorthatcoverboththeparentCFIandthesubsidiaryCFI.Firmsinthissituationshouldbe permittedtheflexibilitybutnotrequiredtocomplyseparately.Somefirmsmaydecidethatit wouldbemoreappropriatetotreatsubsidiaryCFIsasseparateanddistinctcoveredfinancial institutions,withseparatepoliciesandproceduresandseparatereportingobligationstoadifferent regulator.Othersmayprefertotakeamoreholisticapproachwithrespecttotheirpoliciesandreports. TimingofThresholdDeterminations.Afinancialinstitutionsstatusundertherulewouldbe determinedbyreferencetoasingledatapointthebalancesheetasofitsmostrecentfiscalyearend. Whilethisprovidesobjectivecertainty,italsomaybeproblematicforsomefirmsthatmightcrossa relevantthresholdinsomeyearsbutnotothers.TheAgenciesmaywishtoconsidercreatingamore flexibleprocess,liketheoneemployedforthefederalregistrationofadvisers.SECregisteredadvisers thatbecomeineligibleforfederalregistrationbecauseofadecreaseinassetsundermanagementhavea 180daygraceperiodbeforetheyhavetoderegister.10Similarly,theAgenciescouldpermitfirmsagrace periodaftercrossingthe$1billionor$50billionthresholds.Ifthefirmstotalconsolidatedassetsfell belowthethresholdduringthegraceperiod,itwouldnotmeetthedefinitionofcoveredfinancial institution(orlargercoveredfinancialinstitution). 6. SeparateRequirementsforLargerCoveredFinancialInstitutions Theproposedrulewouldimposetwoadditionalrequirementsoncertaincoveredfinancial institutionswith$50billionormoreintotalconsolidatedassets:(1)themandatorydeferralofa portionofexecutiveofficersincentivecompensation,and(2)boardapprovaloftheincentivebased compensationforanynonexecutiveofficerswhohavetheabilitytoexposethefirmtosubstantial losses. WesharetheconcernsexpressedbyCommissionersCaseyandParedesthattheserequirements
SeeRulesImplementingAmendmentstotheInvestmentAdvisersActof1940,ReleaseNo.IA3110(Nov.19,2010),at footnote68andaccompanyingtext,availableathttp://www.sec.gov/rules/proposed/2010/ia3110.pdf.
10

 Ms.ElizabethMurphy May31,2011 Page9of9 gobeyondwhatisnecessarytofulfillthemandateunderDoddFrank.NothinginSection956suggests adifferentstandardforlargerfirms,andnothingrequirestheAgenciestoproposeexplicitrequirements onthedeferralofexecutivecompensation.Theserequirementscouldimpedetheabilityoflargerfirms toattractexecutiveofficers,placingthematacompetitivedisadvantagecomparedtotheirsomewhat smallerpeers. WerecommendthattheAgenciesreconsidertheserequirementsforlargercoveredfinancial institutions,andadoptthemonlyafterexperiencewiththeruledemonstratesthatthegeneral requirementsarenotsufficienttodealwithincentivecompensationpracticesatlargercoveredfinancial institutions. * * * * * Weappreciateyourconsiderationofourviewsonthisimportanttopic.Ifyouhaveany questionsorneedadditionalinformation,pleasecontactBobGrohowskiat(202)3715430ormeat (202)3265815. Sincerely, /s/KarrieMcMillan KarrieMcMillan GeneralCounsel cc: TheHonorableMaryL.Schapiro TheHonorableKathleenL.Casey TheHonorableElisseB.Walter TheHonorableLuisA.Aguilar TheHonorableTroyA.Paredes EileenP.Rominger,Director
DivisionofInvestmentManagement