The American Recovery and Reinvestment Act of 2009 (“ARRA”) was signed into law on February 17, 2009, with the primary purpose of stimulating the American economy. However, ARRA also includes several restrictions on executive compensation and corporate governance that appear to be intended to apply to past recipients, as well as future recipients, of funds under the Troubled Asset Relief Program (“TARP”). ARRA amends Section 111 of the Emergency Economic Stabilization Act of 2008 (“EESA”) to limit bonuses and prohibit golden parachute payments for certain senior and highly compensated employees. It also requires TARP recipients to adopt corporate policies to avoid rewarding excessive risk-taking, recover bonuses under certain circumstances, and reduce or eliminate luxury expenditures.  

Some of these provisions are consistent with guidelines recently adopted by the Department of the Treasury (“Treasury”). See Treasury Department Announces New Restrictions on Executive Compensation, 21st Century Money, Banking & Commerce Alert® (Feb. 6, 2009). Significantly, the ARRA does not include the provisions in the guidelines limiting annual compensation to $500,000 under certain circumstances.  

ARRA prohibits any TARP recipient from paying or accruing bonuses, retention awards, or incentive compensation to certain employees as long as any portion of the recipient’s TARP assistance is outstanding (the “TARP obligation period”). Two exceptions apply. Bonuses may be paid in the form of long-term restricted stock awards that do not exceed in value one-third of an employee’s annual compensation and that do not fully vest until the TARP obligation period is concluded. In addition, written employment contracts executed on or before February 11, 2009, that provide for incentive compensation are grandfathered, subject to the authority of the Secretary of the Treasury (“Secretary”) to determine the validity of the contract. The number of employees of a TARP recipient that are subject to this restriction is based on the amount of TARP assistance received. For institutions that have received or will receive more than $500 million, the restriction applies to the institution’s five most highly paid executives (senior executive officers or “SEOs”), as determined pursuant to the Securities Exchange Act of 1934 (“1934 Act”), and the next 20 most highly compensated employees. Smaller numbers of individuals are covered at lower levels of TARP assistance.  

During the TARP obligation period, golden parachute payments (defined as any payment to a person who departs a company for any reason, except payment for services performed or benefits accrued) are prohibited to any SEO and the next five most highly compensated employees, regardless of the amount of TARP assistance received. This is an important reworking of the golden parachute rules under EESA, which are generally much less restrictive in regard to such payments. ARRA does not contain a grandfather provision to address pre-existing golden parachute agreements, as is the case for incentive compensation agreements. The Treasury, as part of its standard Securities Purchase Agreement for providing TARP assistance to institutions, requires the SEOs of an institution to sign a waiver that releases the US government and the institution from any claims the SEOs may have against either of them as a result of changes to their compensation or benefits that are required to comply with the Treasury regulations on executive compensation in effect on October 20, 2008. However, on its face, such a waiver does not extend to the restrictions on golden parachute payments contained in ARRA, which was adopted four months later. Thus, an SEO who signed such a waiver, or another employee who did not sign any waiver, and who is denied golden parachute payments based on the retroactive application of the prohibition in ARRA, might dispute the government’s authority to impact the operation of his or her contract with his or her employer. Alternatively, employees who are harmed might have a claim against the government under the takings clause of the Fifth Amendment of the US Constitution.  

Any compensation plan that encourages any SEO to take unnecessary and excessive risks that threaten the value of the institution, or that encourages the manipulation of reported earnings, is prohibited. The TARP recipient also must include a provision in any bonus, retention award, or incentive compensation plan that permits the recovery of any payment made to any SEO and the next 20 most highly compensated employees if it is determined that such payment was based on materially inaccurate financial statements. In addition, the Secretary is required to review the bonus, retention, or incentive payments made to the SEOs and the next 20 most highly compensated employees before ARRA was enacted and to “negotiate” with the TARP recipient and the employee for “appropriate reimbursement” to the government of any payments that the Secretary determines were “inconsistent” with the purposes of TARP or the new restrictions or were otherwise contrary to the public interest.  

The restrictions under ARRA apply to “each TARP recipient.” The standard Securities Purchase Agreement authorizes the Treasury unilaterally to amend any provision of the agreement to the extent required to comply with any changes in applicable federal law that occur after the date of its execution. On this basis, the Treasury may seek to apply the new rules retroactively to all TARP recipients to date, as well as to future recipients. In apparent response to concerns about the resulting retroactive application of ARRA’s executive compensation limitations, the Act makes it easier for TARP recipients to repay their TARP assistance and thereby withdraw from the program.  

In addition to the executive compensation measures discussed above, ARRA requires each TARP recipient to adopt certain corporate governance measures. The board of directors must adopt a company-wide policy on excessive or luxury expenditures. This requirement reflects the apparent displeasure of Congress with certain high-profile expenditures by some TARP recipients. Expenditures on items such as entertainment or promotional events, office renovations, aviation and other transportation services, and any other activities that are not reasonable for staff development or as performance incentives must be addressed by the policy. The board of directors also must generally appoint a compensation committee composed entirely of independent directors to review compensation plans. Finally, at any meeting of shareholders for which there is a proxy solicitation, a nonbinding resolution on executive compensation must be introduced for a separate vote, accompanied by all the compensation disclosures, tables, and discussions required by the 1934 Act.  

The executive compensation restrictions in ARRA streamline the pre-existing combination of guidelines and interim final rules, but also inject new uncertainty as to what is required to remain in compliance with TARP. In some cases, it is not clear how previous Treasury rules and guidance will square with ARRA. To that end, it is likely that Treasury will promptly issue new regulations that comprehensively address the executive compensation restrictions applicable to TARP recipients and their employees.

Some executive compensation restrictions that were part of the Senate version of ARRA were dropped or modified during negotiations with the House, most notably a proposed cap of $400,000 on the cash compensation of all employees of TARP recipients and the retroactive recovery of bonuses in excess of $100,000. In addition, as noted above, the guidelines promulgated by the Treasury on February 4, 2008, include a cap on compensation for senior executives under certain circumstances of $500,000 plus restricted stock bonuses, and President Obama has proposed an executive compensation conference to be hosted by the Treasury. Therefore, it remains to be seen whether these or other restrictions on executive compensation will become part of the Treasury’s implementation of ARRA or are separately resurrected in the future.