Section 7001 of the American Recovery and Reinvestment Act ("ARRA"), enacted Feb. 17, 2009, represents a significant foray into direct federal government regulation of executive compensation. The statute mandates compensation limitations for those financial institutions that receive financial assistance from the federal government under the Troubled Assets Relief Program ("TARP") established under Section 110 of the Emergency Economic Stabilization Act of 2008 ("EESA"). However, likely as a result of the haste with which the statute was enacted, the text is fraught with ambiguities.

Under ARRA, the Secretary of the Treasury is authorized and directed to adopt regulations to implement the statute. As of this writing, no regulations have yet been adopted. This memorandum will summarize those areas in which clarification by Treasury, and in some cases the Securities and Exchange Commission as well, would be helpful in interpreting and applying the statute, and can provide a framework for review and analysis of the regulations, when issued.

Effective Date

In a number of respects, the effective date of the new requirements imposed by ARRA could be made clearer. The statute was enacted Feb. 17, 2009, amending and restating in full the previously enacted Section 111 of EESA. Absent some provision in the text establishing a different effective date, Feb. 17 would be the date on which the statute's legal requirements become operative. However, at least for certain of the new requirements, this conclusion is countermanded by the statute's requirement that the Secretary of the Treasury adopt regulations, and by expressing the applicable requirements as a prohibition on violating the regulations, when adopted.

New Section 111(b)(1)(A) (12 U.S.C. §5221(b)(1)(A)) provides that TARP recipients "shall be subject to the standards established by the Secretary under this section...." Section 111(b)(2) states that "the Secretary shall require each TARP recipient to meet appropriate standards for executive compensation and corporate governance." Section 111(b)(3) requires that the standards established under (b)(2) must contain specified terms. These include, for example, a prohibition on the TARP recipient paying or accruing any bonus to specified executives, with an exception for the payment of long-term restricted stock meeting certain requirements. The standards are also required to include a prohibition on the TARP recipient making any "golden parachute" payment (as defined) to specified officers.

While the statute does mandate that the Treasury standards include specified content, the operative prohibition is expressed in terms of a statement that the financial institution shall be subject to standards established by Treasury. This language suggests that until standards have been established, presumably containing the required content together with additional detailed guidance, there are no standards to which the institution is required to be subject, and thus there is imposed no substantive restriction on compensation. Stated differently, it is the regulatory standard, when adopted, that imposes the restriction on compensation, and the statute is not self-operative in this regard. This reading of the text is further supported by the fact that the regulations can be expected to provide much-needed guidance as to the specifics of the operation of the prohibition. Without such guidance, a financial institution is left with great uncertainty as to how compliance with the requirements is to be achieved, arguing that the legal requirement of compliance should not be effective until the required guidance is published. Although this appears to be the proper reading of the text of the statute, Treasury regulations, when adopted, could further clarify this point.

Additional statutory requirements with respect to executive compensation are imposed by new Section 111(b)(4) and 111(c)-(h), under somewhat different statutory language contemplating implementing regulatory action.

Section 111(b)(4) requires that an officer certification of compliance "with the requirements of this section," i.e., Section 111, be included in the institution's annual reports with the Securities and Exchange Commission (if it is a public company). By its terms, the statute does not, in contrast to the substantive compensation requirements, make regulatory action by the applicable agency (here, the SEC) a prerequisite to effectiveness of this requirement. As a result, the requirement would appear to be immediately operative upon enactment of the statute (and as such would have imposed for calendar-year companies, a requirement to include a certification in the Form 10-K for 2008, due shortly after the statute's enactment). However, the fact that at least some of the requirements of the section required to be certified to are themselves not immediately effective, calls into question the time of effectiveness of the statute's certification requirement. Sen. Dodd (D-Conn.), a principal proponent of these provisions, sent a letter to the Chair of the SEC stating his view that this certification requirement is not yet effective, and that the executives will not be required to certify as to their company's compliance with the requirements of Section 111 until standards have been established. This is a sensible view, but the fact that the Senator felt this informal guidance was necessary points up the ambiguity of the statute, which could be clarified, in this case, by regulation of the SEC. In informal interpretations, the SEC has already indicated its agreement with the position.

Section 111(c)(1) of the statute requires, without a stated regulatory prerequisite, that each TARP recipient (which is a public company) shall establish a Board Compensation Committee, comprised entirely of independent directors, for the purpose of reviewing employee compensation plans, and, per 111(c)(2), the committee is required to meet at least semiannually to discuss and evaluate employee compensation plans in light of an assessment of any risk posed to the TARP recipient from such plans. This requirement would appear to be effective immediately upon the statute's enactment. However, this conclusion is clouded by the fact that among the standards the Treasury is directed to establish under 111(b)(3), and with which institutions are to be required to comply under 111(b)(2), is a standard requiring the establishment of a Board Compensation Committee that meets the requirements of 111(c). It would helpful if Treasury regulations, when issued, would clarify that the 111(c) requirement is similarly effective only upon the effectiveness of the issued regulations.

Section 111(d) of the statute requires the board of directors of any TARP recipient to have in place a company-wide policy regarding excessive or luxury expenditures "as identified by the Secretary." The statute continues that the expenditures so identified "may include" excessive expenditures on entertainment, office renovations, aviation and other specified activities. Since by its terms the policy is required to relate to expenditures that, as of enactment of the statute and prior to regulatory action, cannot be identified, presumably, the effective date of this requirement should be the time of effectiveness of regulations on the matter. The regulations, when adopted, could clarify this point.

Section 111(e) of the statute requires, without a regulatory prerequisite, that a TARP recipient permit at its annual or other meeting an advisory vote of shareholders to approve the compensation of executives. The statute states in Section 111(e)(3) that the Securities and Exchange Commission "shall issue any final rules and regulations required by this subsection" not later than one year after the statute's enactment. This raised a question as to whether the requirement for such a vote was effective before such regulations were issued. Sen. Dodd, in the letter described above, stated his view that the provision would not apply to preliminary (or the related definitive proxy even if filed after Feb. 17) or definitive proxy statements filed on or before Feb. 17, but would apply to proxies filed after. Although this appears to be a sensible approach, and one the SEC staff has indicated it would follow, it would be helpful if regulations issued by the SEC would in an authoritative manner confirm this point.


A number of the compensation restrictions imposed by new Section 111 apply to "senior executive officers." The term is defined in Section 111(a)(1) as "an individual who is 1 of the top 5 most highly paid executives of a public company, whose compensation is required to be disclosed" under applicable SEC disclosure rules. It would be desirable if Treasury regulation clarified this definition in a manner that more closely tracks the Item 402 of Regulation S-K requirements. For example, disclosure of the compensation of the CEO and CFO is required even if they do not rank in the top five. But under a literal reading of the statute, these individuals would not be SEOs if they do not rank in the top five most highly compensated executives, a result that presumably was not intended.

In addition, regulations are required to deal with the issue of when a determination of SEOs is made. Presumably, these will follow the pre-ARRA Interim Final Rules that generally gear SEO status at any time to compensation received with respect to the prior fiscal year. The regulations should seek to clarify the operation of bonuses with regard to the determination of SEO status, and the resulting circular prohibition of those same bonuses. Ordinarily, bonuses paid in a subsequent year with respect to the prior year's performance are included, for SEC disclosure purposes, in the prior year's compensation, and thus, under the pre-ARRA Interim Final Rules, would be included in determining whether the recipient is an SEO for the current year, the year in which the bonuses are actually paid. However, if by virtue of inclusion of the bonus in the prior year's compensation, the individual becomes an SEO, the bonus, under the statute, may be prohibited, raising the circular question of whether in the absence of the bonus, the person should in turn now be deemed a non-SEO, which in turn would permit the bonus to be paid, etc.

A number of the compensation restrictions in new Section 111 apply to employees in addition to SEOs, based on their compensation. Here, in the absence of statutory definition, the Treasury regulations can be helpful in prescribing how the compensation of such employees should be calculated, and for what period, in determining which employees are in the category requiring application of compensation restrictions. Again, the bonus circularity problem is present.

Preexisting Contracts

Section 111(b)(3)(C) requires that Treasury standards include a prohibition on a TARP recipient making any payment to a senior executive officer for departure from the company for any reason, except for payments for services performed or benefits accrued. Unlike the restriction on bonus payments provided in 111(b)(3)(D), there is no exception expressed in the statute for payments of this nature required to be paid pursuant to a written employment contract executed on or before Feb. 11, 2009.

As a condition of participation in the TARP program, many financial institutions secured agreements from executives to modifications in their compensation arrangements as necessary to comply with Section 111(b) of the Economic Emergency Stabilization Act of 2008, as implemented by regulations issued and effective as of the closing date of the institution's obtaining TARP funds. However, such regulations did not contain an absolute prohibition on departure payments, and consequently, valid employment agreements with individuals in many cases retain provisions requiring such payments. Treasury regulatory guidance is needed to establish whether in these situations the provision in new Section 111(b)(3)(C) remains applicable, and if so, whether financial institutions are actually intended to be required to breach validly entered contracts.

Compensation Committees

Section 111(c)(2) requires the financial institution's Compensation Committee to meet at least semiannually to discuss and evaluate employee compensation plans in light of an assessment of any risk posed to the TARP recipient from such plans.

This formulation differs from pre-ARRA guidance from Treasury, which had required only annual, rather than semiannual, meetings. Also, the pre-ARRA requirement imposed by Treasury regulation required that the committee meet with senior risk officers, or individuals acting in a similar capacity, to discuss and review the relationship between the financial institution's risk management policies and practices, and SEO incentive compensation arrangements. Additional regulatory guidance from Treasury is now needed to clarify whether the new requirements direct the committee to meet with any particular officers of the company, and whether the new requirements are intended to require an evaluation of compensation plans applicable to all employees of the institution (a potentially daunting task), or whether such review may be limited to plans relating to some group of highly paid individuals.

Review of Other Payments to Executives

Section 111(f) requires the Treasury Secretary to review compensation paid to the senior executive officers and the next 20 most highly compensated employees of each entity receiving TARP assistance before the date of enactment of ARRA, to determine whether any such payments were inconsistent with the purposes of Section 111 or the TARP, or were otherwise contrary to the public interest. If the Secretary makes such determination, the Secretary is required to seek to negotiate with the TARP recipient and the subject employee for appropriate reimbursements to the federal government.

The language of the statute is open to the interpretation that, for an entity receiving TARP assistance before the date of enactment of ARRA, the mandated review of compensation would extend to compensation paid both before and after the enactment of the statute. Such an interpretation would dramatically expand the scope and operation of the statute, by calling into question all post-ARRA payments, whether or not made in compliance with the highly specific statutory prohibitions (as implemented by regulation). It would be helpful if Treasury regulation could clarify that this provision will operate as the title of the section ("Review of Prior Payments to Executives") suggests, only to mandate review of pre-ARRA payments made to specified executives at a time when the financial institution had TARP obligations outstanding.

It would also be helpful if Treasury regulation could confirm that the review would actually extend to payments made prior to the effective date of the ARRA prohibitions, in those cases where the prohibitions became effective at the time of the issuance of regulations, as opposed to the date of enactment of the statute.

TARP Financial Obligations Outstanding

Generally, the compensation restrictions imposed by ARRA apply during the period when any obligation "arising from" financial assistance provided under the TARP remains outstanding. Section 111(g) expressly permits repayment of assistance provided under the TARP, without regard to whether the financial institution has replaced such funds from any other source. Treasury regulation could be helpful in confirming that an obligation incurred by the financial institution to supply funds that are used to repay TARP financial assistance does not itself constitute an obligation "arising from" such financial assistance for these purposes.