As part of the continuing drama of the evolution of the executive compensation restrictions under the Emergency Economic Stabilization Act of 2008 (“EESA”), in the waning hours of the Bush Administration, Treasury announced new reporting and recordkeeping requirements and some “clarifications” with respect to the executive compensation standards under the Troubled Asset Relief Program’s (“TARP”) Capital Purchase Program (“CPP”). The new guidance is contained in a proposed new interim final rule with respect to the CPP executive compensation standards (the “proposed rule”) and in Frequently Asked Questions (“FAQs”). (At the same time, Treasury also issued a revised Notice 2008-PSSFI, relating to financial institutions participating in the program for Systemically Significant Failing Institutions.)

We refer to the interim final rule as “proposed” as it has not yet been published in the Federal Register. Thus, it is subject to review and possible revision by the new Administration. Given the increasing focus on executive compensation by the Congress and the Administration, it can be expected that any requirements imposed by any final rule would be no less stringent than those proposed by the Bush Administration. The proposed effective date is also worthy of note, the preamble to the proposed rule indicates the intent to apply the rule to “all financial institutions participating in the CPP” not just those who participate after the rule is finalized. Here again, the expectation is that the effective date of any final rule would be similar. The FAQs, as well as the proposed rule, also provide some additional insights as to Treasury’s interpretation of certain of the substantive CPP executive compensation restrictions.

Proposed New Reporting and Recordkeeping Requirements

In general, the proposed rule would require the CEO to certify compliance with the CPP executive compensation restrictions. The particulars of the certification requirements are summarized as follows:

  • Within 120 days of the closing of the CPP transaction the CEO must certify that the compensation committee has performed the initial compensation risk analysis. (This is in addition to the compensation committee certification required within 90 days of the closing of the CPP transaction.)
  • Within 135 days of the end of the first fiscal year during which Treasury holds a debt or equity position in the institution, the CEO must certify that the annual compensation risk analysis has been performed by the compensation committee, the institution has complied with the claw back provision, the institution has prohibited golden parachute payments, and the institution has instituted procedures to limit the deduction for SEO compensation to $500,000. The certification must also identify the SEOs for the current fiscal year.
  • Within 135 days of the end of each subsequent fiscal year in which Treasury holds an interest in the institution, the CEO certification must include the information described above and a statement that the institution in fact has limited the deduction for SEO compensation to $500,000 for the most recently ended fiscal year.  

The certifications must be provided to the TARP Chief Compliance Officer and the transfer agent under the CPP. Records substantiating such certifications must be maintained for 6 years; for the first two years the records must be in an “easily accessible” place. The records must be provided to the TARP Chief Compliance Officer upon request.

Identification of SEOs

The first interim final rule with respect to the CPP compensation standards (the “October 20 rule”) contained some language that was confusing to many with regard to how the SEOs are determined, in particular, whether current year or prior year compensation is taken into account in determining the highest paid executive officers (other than the CEO and CFO) . The October 20 rule stated (apparently clearly) that such SEOs are determined based on “total compensation for the last completed fiscal year.” The rule then went on to confuse the point by stating that “[u]ntil compensation data for the current fiscal year are available, the financial institution should make its best efforts to identify the three mostly highly compensated executive officers for the current fiscal year.”

The FAQs provide clarification here, stating that for the non-tax related compensation standards (such as the limit on golden parachute payments), SEOs are the “named executive officers” who are identified in the annual report on Form 10-K or proxy statement (reporting the compensation for the immediately preceding year). An analogous rule applies to private institutions. Thus, prior year compensation is used with respect to the non-tax compensation standards to identify SEOs. Before an institution identifies its named executive officers for the year, it is to make “best efforts” to identify SEOs. The FAQs also caution that if someone who may be an SEO is involuntarily terminated before the named executive officers for the year have been determined, the institution should refrain from making any parachute payments until the SEOs are identified. In contrast, in applying the $500,000 compensation deduction limitation, SEOs are determined based on current year compensation, rather than prior year compensation. The rationale for this difference is that the limitation on the deduction applies to current year compensation.

Payments Made After Treasury Holds a Debt or Equity Position

Some commentators have argued that the CPP compensation restrictions can be avoided by deferring otherwise restricted payments to a time when Treasury no longer holds a debt or equity position. Those taking this view (and we have not been among them) base their interpretation on wording in EESA and the October 20 rule in various places that restrictions apply to payments “during the period” Treasury holds an interest. Treasury officials have indicated that this is not the intent.

With respect to the deduction limitation, this issue should have been laid to rest by Notice 2008-94, which is incorporated by reference in the October 20 rule. That notice contains explicit rules for applying the deduction limitation to “deferred deduction executive remuneration” which is, generally speaking, compensation earned in one year and paid in another. See Q&A 8 and 9 of Notice 2008-94.

The FAQs clarify Treasury’s view that a similar concept applies with respect to the golden parachute restriction. The golden parachute restriction is based on the aggregate present value of all payments made on account of involuntary termination occurring while Treasury holds a position, including payments made after Treasury no longer holds an interest.

The proposed interim rule makes a similar clarification with respect to the claw back provision. Under the October 20 rule, compensation is subject to claw back if paid during the period Treasury holds a position. For purposes of the claw back, the proposed rule says that an amount is considered “paid” when the SEO obtains a legally binding right to the payment. This has the effect of preventing avoidance of the claw back by deferring payments.