Title VII (Division B) of the American Recovery and Reinvestment Act of 2009[1] (the "Stimulus Package Act") further limits executive compensation for financial institutions receiving assistance under the Troubled Asset Relief Program ("TARP") enacted in the Emergency Economic Stabilization Act of 2008 ("EESA").[2] In particular, the Stimulus Package Act prohibits all severance payments for the top five executives, prohibits all incentive compensation other than restricted stock equal to a maximum of one-third of total compensation, expands the number of executives subject to these limitations compared with the original legislation and in the Treasury?s initial guidance under the TARP Capital Purchase Program (CPP),[3] and imposes new corporate governance requirements on TARP recipients.[4]

Among the new rules is a requirement that TARP-recipient shareholders be given an annual, non-binding "say on pay."[5] All of these rules apply only during the time the TARP recipient has outstanding obligations to the federal government arising from its financial assistance (the "TARP Obligation Period").[6]

Compensation Standards

The Stimulus Package Act requires the Secretary of the Treasury to establish standards to apply to TARP recipients during the TARP Obligation Period.[7] The standards include compensation and corporate governance provisions, as well as the following limitations that apply to the five most highly paid senior executive officers (SEOs) whose compensation is reported on the TARP recipient's proxy statement,[8] and in some cases to a broader group of employees. The provisions apply only during the TARP Obligation Period. The standards, which will be supplemented by regulations and other guidance, include the requirement that the TARP recipient have the following:

  1. Limits on Risk Exposure Incentives. Limits on compensation arrangements that foster the taking of unnecessary and excessive risks that threaten the value of the TARP recipient, thus codifying the similar requirement contained in the initial guidance under the CPP.[9]
  1. Bonus Clawback. An arrangement to recover any bonus, retention award or incentive compensation based on earnings, revenues, gains or other criteria that are later found to be materially inaccurate. The amendment codifies the provision included in the Initial Guidance under the TARP CPP but now extends the clawback beyond amounts paid to any SEO to include the next 20 most highly compensated employees.[10]
  1. Prohibited Severance. A prohibition on "golden parachute" payments, defined to include any payment to an SEO and the next five most highly compensated employees for departure from a company for any reason[11], except for payments for services performed or benefits accrued. The Stimulus Package Act expands the definition of "golden parachute" to extend to all severance and not just severance that would not be deductible for federal income tax purposes.[12]
  1. Limit Incentive Compensation Except for Certain Restricted Stock. A prohibition on paying certain executives any bonus, retention or incentive compensation other than certain long-term restricted stock that meets the following criteria:
  1. does not fully vest during the TARP Obligation Period,
  2. has a value not greater than one-third of the total annual compensation of the employee receiving the stock, and
  3. is subject to such other restrictions as the Secretary of the Treasury may determine are in the public interest. However, the scope of executives subject to these limitations on incentive compensation depends on the magnitude of the federal assistance received by the TARP recipient as indicated in the following table and arrangements pursuant to a written employment agreement executed on or before February 11, 2009, are grandfathered from the limitation on incentive compensation:[13]  see table
  1. Ban on Plans that Encourage Earnings Manipulation. A prohibition on any compensation plan that would encourage manipulation of the reported earnings of a TARP recipient to enhance the compensation of any of its employees.[18]
  1. Required Compensation Committee and Functions.[19] The Stimulus Package Act requires that TARP recipients have a compensation committee that satisfies the following:

(i) is comprised entirely of independent directors (except that the functions can be performed by the board of directors as a whole for a TARP recipient who has received less than $25,000,000),[20] and

(ii) meets at least semiannually to discuss and evaluate employee compensation plans in light of any risks posed to the TARP recipient by such plans.

Limitation on TARP Recipient's Compensation Tax Deductions

Also included in the compensation standards required by the Stimulus Package Act is a requirement that the TARP recipient be subject to the provisions of Section 162(m)(5) of the Internal Revenue Code of 1986, as amended, which limits the deduction for compensation paid to certain senior executives to $500,000.[21]

Limits on Luxury Expenditures

The Stimulus Package Act also includes provisions requiring the board of directors of each TARP recipient to have in place a company-wide policy regarding excessive or luxury expenditures, as identified by the Secretary of the Treasury, which may include 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 operation of the TARP recipient."[22]

Shareholder Non-Binding "Say on Pay"

The Stimulus Package Act requires each TARP recipient to provide its shareholders during the TARP Obligation Period with a non-binding vote on senior executive compensation annually. For a public company, this can be accomplished through a non-binding resolution voted as a separate shareholder vote to approve the compensation of executives as disclosed pursuant to the Securities & Exchange Commission (SEC) rules, including the compensation discussion and analysis, compensation tables, and any related material.[23]

Compliance Certifications

The Stimulus Package Act also includes provisions requiring a written certification by the TARP recipient's chief executive officer and chief financial officer (or their equivalents) of compliance with the provisions of EESA Section 111 outlined in this Alert. For a public company, the certification is to be made to the SEC with its annual filings, and in the case of other TARP recipients, to the Secretary of the Treasury.[24]

Treasury Review Excessive Bonuses Previously Paid

The Secretary of the Treasury is also directed under the Stimulus Package Act to review all compensation paid to SEOs and the next 20 most highly compensated employees of each entity that was a TARP recipient before the date of enactment to determine whether any such payments were "inconsistent with the purposes" of the new rules or were "otherwise contrary to the public interest." And if so, is directed to negotiate for appropriate reimbursements to the federal government. [25]

Bailing Out of the Bailout

The amendments conclude with a provision stating that with appropriate consultation with the appropriate federal banking agency, the Secretary of the Treasury will permit a TARP recipient to repay any assistance previously provided under the TARP, without regard to whether the institution has replaced the funds, and when such assistance is repaid, the Secretary is to liquidate any warrants associated with the assistance at the current market price.[26]

Retroactive Effect

The executive compensation limitations and governance provisions imposed by the Stimulus Package Act amendments to EESA Section 111 appear intended to apply retroactively to all TARP recipients, including to financial institutions that received funds under the CPP and other TARP programs.[  

Summary of Stimulus Package Act Executive Compensation Limitations on Most Highly Compensated Employees