Jonathan Foxx
Managing Director
Production incentives have been around since the dawn of modern capitalism. They are not going anywhere. Incentives have been called sales incentives, sales bonuses, compensation bonuses, and take into account any additional remuneration that tends to be transactionally based. All such incentives can be grouped into business objectives where a transaction may be tied to certain benchmarks, met by employees or service providers, the achievement of which leads to an increase in wage or reward for the party achieving the stated goal. For the sake of discussion, let’s call forms of such economic inducement, collectively, as “incentives.”
Managing Director
Production incentives have been around since the dawn of modern capitalism. They are not going anywhere. Incentives have been called sales incentives, sales bonuses, compensation bonuses, and take into account any additional remuneration that tends to be transactionally based. All such incentives can be grouped into business objectives where a transaction may be tied to certain benchmarks, met by employees or service providers, the achievement of which leads to an increase in wage or reward for the party achieving the stated goal. For the sake of discussion, let’s call forms of such economic inducement, collectively, as “incentives.”
Typical incentives include cross-selling, where
sales or referrals of new products or services are pitched to existing
consumers; sales of products or services to new customers; sales at higher
prices where pricing discretion exists; quotas for customer calls completed;
and collections benchmarks.
Some of these incentives are very complex in the
way they are achieved and applied, whether optionally or required. The
incentive challenge is one of the usual conundrums arising when money and
capital formation meet: the opportunity for harm to the consumer. Obviously,
incentives offer a way to further enhance revenue for the seller of services
and products. Indeed, in our market economy, an incentive can reveal the
economic interest of market participants in a particular service or product,
which is extrapolated from consumers’ responses to the offerings. Like so much
in finance, incentives are not inherently good or bad, but how they are applied
makes them so!
The Consumer Financial Protection Bureau (“Bureau”)
has decided to weigh in with guidance on production incentives. I am going to
provide my reading of the Bureau’s most recent bulletin on this topic, entitled
“Detecting and Preventing Consumer Harm from Production Incentives” (Bulletin
2016-03, November 28, 2016, hereinafter “Bulletin”). It is an interesting read,
because it endeavors not only to compile guidance that the Bureau had provided
in other contexts but also draws on the Bureau’s supervisory and enforcement
experience in which incentives contributed to substantial consumer harm.
Importantly, the Bulletin offers some actions that supervised entities should
take to mitigate risks posed by incentives.
This White Paper article is an adjunct to an earlier published web article (December 2016), with further elaboration herein, plus now including a "Compliance Checklist for Production Incentives," which provides some helpful guidelines to creating production incentive plans. The full White Paper, Article, and Compliance Checklist may be downloaded from our firm's website at LendersComplianceGroup.com.
RISKS
The most obvious risk of incentives to the consumer
is a sales program that includes an enhanced economic motivation for employees
or service providers to pursue overly aggressive marketing, sales, servicing,
or collections tactics. These kinds of incentives are and always have been
features of sales tactics that do not meet regulatory scrutiny. Consequently,
it is the case that the Bureau has taken enforcement action against financial
institutions that have expected or required employees to open accounts or
enroll consumers in services without consent or where employees or service
providers have misled consumers into purchasing products the consumers did not
want, were unaware would harm them financially, or came with an unexpected
ongoing periodic fee.
One or more regulatory violations may be triggered
as a result of such incentives. To name but a few of the more salient
regulatory frameworks that can be violated, impermissible incentives can cause
violations of unfair, deceptive, and/or abusive acts or practices (UDAAP)
(Dodd-Frank Act, §§ 1031 & 1036(a), codified at 12 USC §§ 5531 &
5536(a), the Electronic Fund Transfer Act (EFTA), as implemented by Regulation
E (15 USC § 1693 et seq.; 12 CFR Part 1005); the Fair Credit Reporting Act, as
implemented by Regulation V (15 USC § 1681-1681x; 12 CFR Part 1022); the Truth
in Lending Act (TILA), as implemented by Regulation Z (15 USC § 1601 et seq.;
12 CFR Part 1026); and the Fair Debt Collection Practices Act (15 USC §
1692-1692p). And to this the Bureau itself notes that violations can stir up
public enforcement, supervisory actions, private litigation, reputational harm,
and potential alienation of existing and future customers.
Although not meant to be comprehensive, here are
some impermissible incentives that surely trigger regulatory violations:
- Opening Accounts: sales goals that encourage employees, either directly or indirectly, to open accounts or enroll consumers in services without their knowledge or consent, which may result in improperly incurred fees, improper collections activities, and/or negative effects on consumer credit scores;
- Benchmarks: sales benchmarks that encourage employees or service providers to market a product deceptively to consumers who may not benefit from or even qualify for it;
- Terms or Conditions: paying compensation based on the terms or conditions of transactions (such as interest rate) that encourages employees or service providers to overcharge consumers, to place them in less favorable products than they qualify for, or to sell them more credit or services than they had requested or needed;
- Tiered Compensation: paying more compensation for some types of transactions than for others that were or could have been offered to meet consumer needs, which could lead employees or service providers to steer consumers to transactions not in their interests; and
- Quotas: unrealistic quotas to sign consumers up for financial services may incentivize employees to achieve this result without actual consent or by means of deception.
ACTION PLAN
As I have often said, the
evaluation of risk is just the first step to mitigating it. Sometimes, it is
the easiest step! When dealing with incentives, the risk to the consumer – and mutatis mutandis to the financial
institution – is mitigated through effective controls. Some people seem to balk
at internal controls, as if their implementation is reflective of a personal
bias. It is not. It is just the way to establish a means by which to regulate
behavior that is lawful and acceptably fair to all market participants. Too
many regulations can stifle financial opportunities; but too few regulations
can cause the market to explode.
From what we have been able to
determine, both from its supervisory issuances and its enforcement actions, the
Bureau certainly wants to provide a means whereby a financial institution can
gauge its compliance with consumer financial protection laws as it relates to
incentives. This is why it has often stated - such as in issuing its
“Supervision and Examination Manual: Compliance Management Review” - the
importance of implementing a Compliance Management System, otherwise
known by its acronym, “CMS.”
Indeed, because my firm believes
so strongly in ensuring that our monthly clients are fully prepared with their
CMS, we developed our annual CMS Tune-up!™, which is an evaluation of a
financial institution’s compliance management system. We provide an executive
report and a risk rating to these clients at no additional charge. It is a
critical responsibility of management to set up and implement a CMS, the review
of which will certainly be undertaken by both federal and state regulators.
If our CMS Tune-up!™ shows the
presence of production incentives, we are going to rate the risk based on where
those incentives concern products or services less likely to benefit consumers,
or have a higher potential to lead to consumer harm, or reward outcomes that do
not necessarily align with consumer interests, or implicate a significant
proportion of employee compensation.
Thus, instituting a compliance
management system, a CMS, is at the core of effective compliance with the
Bureau’s expectations in its supervision and enforcement of permissible
incentives. Essentially, there are four components to the Bureau’s conception
of a viable CMS: these are (1) the oversight by the Board of Directors or management;
(2) a ratified and comprehensive compliance program, consisting of policies and
procedures, training, monitoring, and corrective action; (3) a consumer
complaint management program; and (4) an independent compliance audit.
Let’s apply the CMS framework to
a few ways and means for limiting violations arising from incentives that may
trigger violations of law.
Board of directors and management oversight.
Foster a culture of strong
customer service related to incentives. In product sales, for instance, ensure
that consumers are only offered products likely to benefit their interests.
Policies and procedures
Ensure that the policies and
procedures for incentives contain:
- Employee sales/collections quotas that, if a part of an entity’s incentive program, are transparent to employees and reasonably attainable;
- Clear controls for managing the risk inherent in each stage of the product life cycle (as applicable): marketing, sales (including account opening), servicing, and collections;
- Mechanisms to identify potential conflicts of interest posed for supervisory personnel who are covered by incentives but also are responsible for monitoring the quality of customer treatment and customer satisfaction; and
- Fair and independent processes for investigating reported issues of suspected improper behavior.
Training
Implement comprehensive training
that addresses:
- Expectations for incentives, including standards of ethical behavior;
- Common risky behaviors for employees and service providers to foster greater awareness of primary risk areas;
- Terms and conditions of the institution’s products and services so that they can be effectively described to consumers; and
- Regulatory and business requirements for obtaining and maintaining evidence of consumer consent.
Monitoring
Design overall compliance
monitoring programs that track key metrics that may indicate incentives are
leading to improper behavior by employees or service providers. Examples of
possible monitoring metrics include, but are not limited to:
- Overall product penetration rates by consumer and household;
- Specific penetration rates for products and services (such as overdraft, add-on products, and online banking), as well as penetration rates by consumer segment;
- Employee turnover and employee satisfaction or complaint rates;
- Spikes and trends in sales (both completed and failed sales) by specific individuals and by units;
- Financial incentive payouts; and
- Account opening/product enrollment and account closure/product cancellation statistics, including by specific individuals and by units, taking into account the terms of the incentive programs (i.e., requirements that accounts be open for a period of time or funded in order for employees to obtain credit under the program).
Corrective Action
Promptly implement corrective
actions to address any incentive issues identified by monitoring reviews as
areas of weakness:
- Corrective actions should include the termination of employees, service providers, and managers, as necessary, and these termination statistics should be analyzed for trends and root cause(s);
- Corrective actions should include changes to the structure of incentives, training on these programs, and return of funds to all affected consumers as appropriate in light of failed sales or heightened levels of customer dissatisfaction;
- All corrective actions should ensure that the root causes of deficiencies are identified and resolved; and
- Findings should be escalated to management and the board, particularly where they appear to pose significant risks to consumers.
Consumer Complaint Management Program
Collect and analyze consumer
complaints for indications that incentives are leading to violations of law or
harm to consumers in order to identify and resolve the root causes of any such
issues.
Independent Compliance Audit
Schedule audits to address
incentives and consumer outcomes across all products or services to which they
apply, ensuring audits are conducted independently of both the compliance
program and the business functions, and ensuring that all necessary corrective
actions are promptly implemented.
Whether a financial institution
uses our CMS Tune-up!™ or has the resources to objectively evaluate the
foregoing elements of a compliance management system on its own, the CMS
approach to internal control is a necessity. There must be a careful, ongoing,
systemic, procedural, testable, traceable, and evaluative means by which to
ensure that incentives are rigorously supervised throughout the service and
product delivery process.
Compliance Checklist for Production Incentives
CATEGORY
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ACTION ITEMS
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SYSTEMS
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System solution is capable
of collecting the
right kind of information to allow proper risk management
Audit procedures are established to
review effectiveness and appropriateness of system solution
System solution allows identification
of the following (where relevant)
o
The types of products and services
o
Individual high risk staff
members (i.e., sales
pattern, fear of disciplinary action)
o
Sales staff who are
achieving high sales
volumes and the
products they are selling
o
Patterns in individual sales
activity (i.e., spikes
before any target
cut-off dates)
o
Effects of product promotions and
sales campaign
o
Claim repudiation of rates and/or
cancellation rates
o
If claw-backs are permitted by law,
the levels of claw backs for individual sales staff
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monitoring
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In addition to routine monitoring
and checking that sales are carried out according to the firm's sales
guidelines, risk-based monitoring processes are also in place:
·
Where there is an indication of
impermissible selling or higher risk of impermissible selling, additional
monitoring is put in place
·
Additional scrutiny of
high-performing sales staff
Monitoring is consistent with sales
and bonus strategy (i.e., loan products with highest sales and loan products
which attract large commissions as opposed to monitoring riskier products
only)
During the monitoring process, more
weight is given to mistakes in the sales process than to administrative
errors
·
Root causes of issues are analyzed
(i.e., cancellations)
Where relevant, monitoring also
includes areas such as complaints handling, claims processing, mortgage
arrears and customer retention (viz., risks to consumers from incentive
schemes may also arise in these areas)
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conflicts of interest
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Clear strategy to manage and
mitigate conflicts risks if firm answers Yes to any of the following
questions:
·
Does the supervisor of sales staff
also receive incentive payments based on the volume of sales made by those
staff?
o
If so, does the supervisor of sales
staff also carry out business quality monitoring of his/her own sales staff?
o
Any other conflicts risks?
·
Independent quality checking of
supervision assessments
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inappropriate behavior
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Institution has considered the types
of inappropriate behaviors that might occur as a result of the firm's
incentive plans, taking into account the types of loan products being sold
and the methods of distribution
Suitable training is in place, among
other things, to ensure that staff, supervisors and management understanding
the meaning and practice of "impermissible sales” and "failure to
deliver fair outcomes for consumers"
Organization actively assesses what
is being said to customers, for example, by using the following controls:
·
Mystery shopping
·
Contact sample consumers after sales
(testing outcomes (i.e., correct information was given) and not simply
customer satisfaction)
·
Record telephone calls
·
Monitor telephone calls
·
Record face-to-face sales
conversation for later review
Past business sampling to identify
if any systemically impermissible sales have occurred because of higher risk
features in incentive schemes
Output of controls:
·
Management reviews output of
controls
·
Results are placed into individual
training and competency monitoring
·
Indications of non-compliance are
escalated and acted upon on a timely basis
Emphasis on poor quality performance:
action is taken
·
Staff is aware of and reminded of
consequences of compliance failures
·
Individual performance assessments
based on both quantitative (financial) and qualitative (non-financial)
factors (i.e., qualitative factors include compliance with regulation,
internal procedures, market conduct standards, business retention rates, and number
of complaints upheld)
·
Qualitative factors affect
remuneration of sales manager and advisers
o
staff removed from bonus scheme or
bonus significantly reduced if quality standards are not met
o
Incentive payments already received
are clawed-back or off-set against future incentives (i.e., for poor outcomes
or if consumers cancel)
·
Disciplinary measures
·
Additional training given to staff
with persistent compliance failures
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culture of compliance *
* Terminology developed by Jonathan Foxx, Managing Director, Lenders
Compliance Group. See article entitled “Creating a Culture of Compliance”
(National Mortgage Professional Magazine, February 2014)
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Management
has clear answers to the following:
·
In what way does the institution
have a culture of putting customers first?
·
Are incentive plans aligned to the
goals of the organization?
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risk calibration
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Institution identifies, assesses,
and documents specific features of its incentive plans that might increase
the risk of impermissible selling (see below, RISK
ACCELERATORS)
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incentive policy & implementation
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Management has clear understanding
of how incentive plans operate and how they meet regulatory requirements,
with outline of same approved and in a written outline
Criteria used by institution to
assess performance of relevant staff are accessible, understandable, and in
writing
Relevant staff are clearly informed
at the outset of:
·
the criteria used to determine their
remuneration
·
steps and timing of their
performance reviews
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incentive plan outlines
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Plans are not overly complex
Institution considers all relevant
factors when designing am incentive plan:
·
Role performed by relevant person
·
Type of loan products offered
·
Methods of distribution
Institution uses features in its
incentives plans that reduce the risk of impermissible selling, for instance:
·
Emphasis on sales quality:
qualitative criteria included in calculation of remuneration
·
Claw backs
·
Variable remuneration:
o
References used in calculation of
variable remuneration of staff are common across loan products sold
o
Ratio between variable and fixed
income reflects desired conduct of employees to act in the best interests of
clients (i.e., bonus is limited to a lower proportion of basic salary)
o
Variable remuneration is paid out in
several payments over a period, in order to take into account long-term
results
o
Capped or decreasing incentives
(i.e., bonuses are capped or reduced when sales volume approaches a certain
level or bonus is limited to a lower proportion of basic salary)
o
Policy on payment is flexible and,
where appropriate, includes possibility of not paying any variable
remuneration
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Approvals
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Management approves incentive plans
with input from risk management and compliance functions
o
Drafts such approvals guidelines
into the plan design and incentive policies reviews
Compliance function verifies that
institution’s remuneration practices comply with federal and/or state
regulatory guidelines, including applicable employment law
Compliance personnel have access to
all relevant documentation
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Reviews
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Frequent and effective department
and function reviews of written remuneration policies and incentive plans and
related controls
Internal and/or external testing and
audit to determine compliance with policies and procedures, with results of
same given to management
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Reporting Lines
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Appropriate and transparent
reporting and chain of command lines to assist in timely escalation of
problems
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Controls
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Controls are established to identify
and mitigate increased risks
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Outsourced Entities
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Ensure that outsourced entities
apply controls and arrangements to mitigate risks that, at minimum, are at
the same level as the institution’s own risk tolerance
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Governance Group
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Where appropriate, institution has a formal
governance group (reporting to the remuneration committee or senior
management) that ensures incentive plans are consistent with the firm's
remuneration policies
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Groups
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Appropriate remuneration policies
are not circumvented at individual or group-wide level (i.e., use of
off-shore or outsourced entities)
Affiliates to have the group
remuneration policy applied and the requirement of subsidiaries to take into
account local responsibilities (viz., based on risk profile and regulatory
environment)
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risk accelerators
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EXAMPLES
OF SIGNIFICANT INCREASE OF IMPERMISSIABLE RISK
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Disproportionate rewards for
marginal sales
(Target/goal
triggers an increase in earnings which is much higher than the normal rate at
which incentives accrue.)
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Retrospective accelerator: level of
incentives earned for all sales in a period, rather than just the sales above
target, increases once a target is reached
"First past the post"
competition bonus (i.e., first 25 sales people to reach the target earn a
"super bonus")
Locked-in enhanced commission: once
a target is met, sales people are locked in to an enhanced commission for the
next year
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Stepped payments
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Higher rate of incentive applies to
sales over a target
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Inappropriate incentive
bias between products
(Even
higher risk where incentives are different for substitutable products)
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Sales people are biased towards loan
products with higher commissions attached
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Variable salaries
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Staff moves between salary bands or
tiers depending on their performance against sales targets
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Inappropriate
requirements for determining staff eligibility for incentives
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Incentive payments are accrued but
not paid unless a minimum target is met for each of several types of loan
products (i.e., bonus paid only if a percentage of the sales person's clients
have purchased certain services or products, such as an insurance product)
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Bonus above
thresholds
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Once a target is met, staff receive
bonuses on each sale above the target
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Campaigns
or competitions
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Product-specific or volume-based
competitions designed to increase sales
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Compliance Checklist for Production
Incentives is meant to be suggestive, rather than comprehensive.
Each financial institution should evaluate its incentive plans in accordance
with federal and state guidelines, and applicable employment law, as well as ensure
these are reflective of its size, complexity, and risk profile. Information contained
herein is not intended to be and is not a source of legal advice.
© 2017 Lenders Compliance Group, Inc. All Rights Reserved.
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