Summary of Executive Compensation Limits on TARP Recipients
February 23, 2009
The economic stimulus bill, titled the American Recovery and Reinvestment Act of 2009 (the “Act”) includes a provision limiting executive compensation, and is an amendment of executive compensation limits contained in the Emergency Economic Stabilization Act of 2008 or “EESA” passed last October (hereafter, the executive compensation legislation is referred to as the “Amendment”). The Act adopts new restrictions on compensation for top officers of financial institutions that have or will receive funds pursuant to the Troubled Asset Relief Program or “TARP.” Additional details of the limits will be developed by the Treasury Department, which is given authority to issue standards, and presumably also by the Securities and Exchange Commission. The prohibitions in the Act apply during the period in which TARP obligations are outstanding, and does not include the period during which the federal government only holds warrants to purchase common stock of the institution.
The Amendment requires TARP recipients to implement the following executive compensation restrictions and corporate governance standards during the period in which TARP obligations are outstanding:
Excessive risk-taking. Compensation may not include incentives for senior executive officers for taking “unnecessary and excessive risks” that threaten the value of the institution. The term senior executive officer (“SEO”) refers to a person who is one of the top 5 most highly paid executives of a public company, that is, whose compensation is required to be disclosed under the Securities Exchange Act of 1934 and accompanying regulations. The term also includes “non-public company counterparts,” which is not specifically defined but is apparently intended to apply to non-registered companies.
Inaccurate prior results. The institution is required to recover any bonus, retention award, or incentive compensation paid to the SEOs or to the next 20 most highly-compensated employees if the compensation is based on statements of earnings, revenues, gains, or other criteria that are later found to be “materially inaccurate.”
Golden parachutes. The institution may not make any golden parachute payment to the SEOs or any of the next five most highly-compensated employees. A golden parachute payment is defined as any payment to an SEO for departure from a company for any reason, except for payments for services performed or benefits accrued.
Incentive compensation. The institution may not pay or accrue bonuses, retention awards and incentive compensation, except for restricted stock that does not “fully vest” during the period when TARP obligations remain outstanding and which has a value of not more than one-third of the total annual compensation of the recipient employee. This prohibition is not to be construed to prohibit any required bonus payment pursuant to a valid written employment contract executed on or before February 11, 2009. Other restrictions may apply as determined by the Secretary of the Treasury.
The number of employees affected by the incentive compensation limit is based on the amount of TARP funds received, as follows:
Less than $25 million: only the most highly compensated employee.
At least $25 million but less than $250 million: “at least” the five most highly-compensated employees, or a higher number as determined by the Secretary of the Treasury for an institution.
At least $250 million but less than $500 million: the SEOs and “at least” nine of the ten next most highly-compensated employees, or a higher number as determined by the Secretary of the Treasury for an institution.
$500 million or more: the SEOs and “at least” the 20 next most highly-compensated employees, or a higher number as determined by the Secretary of the Treasury for an institution.
Earnings manipulation. The institution’s compensation plan may not encourage manipulation of its reported earnings in order to enhance the compensation of any of its employees.
Board oversight/management certification. The institution is required to establish a board compensation committee comprising entirely of independent directors for the purpose of reviewing employee compensation plans. The committee must meet at least semi-annually to discuss and evaluate employee compensation plans and assess any risks posed to the institution from such plans. For non-registered institutions that have received $25 million or less in TARP funds, these duties must be carried out by the board of directors. In addition, the board must establish a company-wide policy regarding excessive or luxury expenditures (as identified by the Secretary of the Treasury), such as expenses for entertainment or events, office and facility renovations, aviation or other transportation services, or “other activities or events that are not reasonable expenditures for staff development, reasonable performance incentives, or other similar measures conducted in the normal course of the business operations of the TARP recipient.”
In addition, the CEO and CFO of each institution (or their equivalents) must provide a written certification of compliance with the compensation and governance restrictions. Registered companies certify to the SEC together with annual filings, and not publicly-traded companies certify to the Secretary of the Treasury.
Shareholder provisions. Shareholders must be allowed a separate shareholder vote (“say on pay”) to approve the compensation of executives, as disclosed pursuant to compensation disclosure rules of the SEC. The shareholder vote is not binding on the board, and may not be construed as overruling a decision by the board, or create any additional fiduciary duty by the board. Also, the vote may not be construed to limit the ability of shareholders to include proposals related to executive compensation in proxy materials. The SEC has one year to issue final rules and regulations to implement this requirement.
Retroactive review. The Amendment requires the Secretary of the Treasury to review bonuses, retention awards, and other compensation paid to SEOs and the next 20 most highly-compensated employees prior to enactment of the Act to determine whether the payments were inconsistent with the purposes of the Amendment or the TARP or were otherwise contrary to the public interest. If Treasury determines that the payments were not made in accordance with its rules, it is required to negotiate with the institution and the recipient to obtain reimbursement of any inappropriate compensation to the government.
Repayment of TARP funds. Perhaps in recognition of these additional restrictions retroactively on TARP recipients, the Amendment requires the Secretary of the Treasury (after consulting with the appropriate federal banking agency of an institution) to allow a TARP recipient to repay received funds without regard to whether the institution has replaced the funds from any other source and without regard to any waiting period and without penalty. Upon repayment, the Treasury will liquidate warrants associated with the funds at the current market price.
Special tax rule. The Amendment specifically emphasizes that TARP institutions are subject to the “Special Rule For Application to Employers Participating in the Troubled Assets Relief Program” codified last year as Section 162(m)(5) of the Internal Revenue Code under EESA. Section 162(m)(5) reduces to $500,000 (from $1 million) the deduction for compensation paid to certain executives by a financial institution that received TARP funds exceeding $300 million. This restriction is not limited to publicly traded institutions.
The restriction applies to the CEO and CFO (or individuals acting in either capacities) and the three other highest compensated officers of the institution. The Treasury Department has published questions and answers regarding IRC Section 162(m)(5) when it was adopted pursuant to the enactment of EESA, and is available at http://www.ustreas.gov/initiatives/eesa/docs/N-08-94.pdf.
Because the Amendment requires Treasury and the SEC to issue implementing rules and guidance, it is not clear whether the restrictions are immediately effective. Also, some key terms are not defined, such as “non-public company counterparts” of public company executives. CBA will track any Treasury and SEC rulemaking in this regard.
The information contained in this CBA Regulatory Compliance Bulletin is not intended to constitute, and should not be received as, legal advice. Please consult with your counsel for more detailed information applicable to your institution.
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