A series of corporate scandals coupled with media attention surrounding the current economic downturn have put fresh scrutiny on executive compensation practices. Senior executives of financial and industrial companies have been called before Congress, and grilled about their pay packages. As Congress and the Administration have been forced to step in to provide assistance to provide enterprises, strings have been attached that require new limitations on executive pay. These limitations are described below, as well as more wide-ranging proposals that would affect all companies regardless of whether they receive government assistance or not.

Emergency Economic Stabilization Act

The Emergency Economic Stabilization Act of 2008 (EESA) enacted sweeping new executive compensation restrictions that apply to companies that participate in financial relief programs initiated under the EESA. While these restrictions apply only to companies that participate in EESA programs, these new restrictions can be expected to serve as a "roadmap" for more broadly applicable restrictions considered in the next Congress.

Who is affected by the EESA's new executive compensation restrictions?

Companies that participate in the Treasury Department's relief programs created under the EESA – the Troubled Asset Auction Program, the Capital Purchase Program, or the Programs for Systemically Significant Failing Institutions – are subject to the new executive compensation restrictions. For affected companies, the new restrictions generally apply to the Chief Executive Officer, Chief Financial Officer, and the next three most highly compensated executive officers.

Summary of New Restrictions and Requirements

The EESA imposes the following new restrictions and requirements on covered employees of affected companies:

  • General Standards and Criteria – Executive compensation arrangements must exclude incentives to "take unnecessary and excessive risks that threaten the value" of the company or firm.
  • Clawbacks – Executive compensation arrangements must include a so-called "clawback" provision for the recovery of any bonus or incentive compensation paid based on statements of earnings, gains, or other criteria that are later proven to be materially inaccurate.
  • Golden Parachute Prohibitions – Companies are prohibited from making any golden parachute payments to covered executives during the period that the federal government holds an equity or debt position in the company. An excise tax also would be imposed on any golden parachute payments made by such companies.
  • Limitations on Deductibility of Executive Compensation – Compensation to covered executives may not be deducted to the extent that compensation exceeds $500,000 for the year. For these purposes, compensation is defined broadly to include both cash and non-cash (e.g., performance-based) compensation.

Other Legislative Proposals

The changes made in the EESA were not the only executive compensation proposals in the 110th Congress. In fact, prior to the EESA, influential Members of Congress – including President-elect Barack Obama – had already put forth a wide array of legislative proposals that would have a direct effect on executive compensation practices and arrangements. Some of the more significant proposals include the following:

  • "Say on Pay" Legislation – requires non-binding shareholder vote on executive pay. (H.R. 1257 (Frank); S. 1181 (Obama))
  • Tax Deductibility – tightens deductibility limitations under Internal Revenue Code (IRC) section 162(m) to restrict compensation in excess of $1 million per year. (S. 349 (Baucus))
  • Non-qualified Deferred Compensation – imposes new limits and restrictions on non-qualified deferred compensation arrangements, e.g., a contribution limit on the amount of compensation that can be deferred. (S. 349 (Baucus))
  • Bankruptcy Law Changes – limits bonuses to executives while a company is in bankruptcy; voids payments made to executives in anticipation of bankruptcy; prohibits deferred compensation when employee plans have been terminated in bankruptcy. (S. 2092 (Durbin); H.R. 3652 (Conyers))
  • Stock Option Restrictions – restricts tax deductibility of stock options to the amount of the expense shown in corporate financial statements; also excludes stock options from the "performance-based" exception under IRC section 162(m). (S. 2116 (Levin))
  • "Clawback" Requirements – expands section 304 of Sarbanes- Oxley by broadening the definition of "misconduct" that triggers requirements that executives reimburse companies for such misconduct. (S. 2866 (Clinton))
  • Mergers & Acquisitions/Golden Parachute Payments – requires shareholder approval of golden parachute payments in connection with mergers and acquisitions. (S. 2866 (Clinton))
  • Compensation Consultants – disclosure or ban on services provided by compensation consultants. (House Government Reform and Oversight Committee report and hearing; S. 2866 (Clinton); CRS Report RL33935)
  • Board of Director Elections – increasing shareholders' role in electing Boards of Directors, e.g., allowing shareholders to nominate directors. (Senate Banking Committee hearing; CRS Report RL33935)
  • Linking Executive Pay to Non-Executive Pay – limit executive pay that exceeds a certain ratio of non-executive pay (e.g., 25 times the lowest-paid employee). (H.R. 3260, 109th Congress; CRS Report RL33935; Institute for Policy Studies/United for a Fair Economy)
  • Government Contracting Requirements – restrict or deny government procurement contracts to firms if executive pay exceeds a certain ratio of non-executive pay. (S. 2866 (Clinton); Institute for Policy Studies/United for a Fair Economy)

Conclusion

Companies must monitor executive compensation legislation very closely – both with an eye towards influencing legislative proposals to avoid unintended consequences and to ensure that they are in compliance with any new laws. Venable's Legislative and Government Affairs practice and its Employee Benefits and Executive Compensation practice are monitoring all developments closely, and stand ready to assist companies at this critical time.