The U.S. Department of the Treasury has issued interim final rules for reporting and recordkeeping requirements under the executive compensation standards of the Troubled Asset Relief Program’s (TARP) Capital Purchase Program (CPP).

Treasury originally published executive compensation standards for CPP last October. The rules generally apply to the chief executive officer, chief financial officer, plus the next three most highly compensated executive officers. These standards include:

  • ensuring that incentive compensation for senior executives does not encourage unnecessary and excessive risks that threaten the value of the financial institution;
  • requiring clawback of any bonus or incentive compensation paid to a senior executive based on statements of earnings, gains, or other criteria that are later proven to be materially inaccurate;
  • prohibiting the financial institution from making any golden parachute payment (based on the Internal Revenue Code provision) to a senior executive; and
  • agreeing not to deduct for tax purposes executive compensation in excess of $500,000 for each senior executive.

New Compliance Regime

This new rule establishes a compliance reporting regime relating to the CPP executive compensation requirements.

Under the new rule, within 120 days of the closing date of the Treasury’s purchase of securities from the financial institution, the chief executive officer (CEO) is required to certify that the compensation committee has reviewed the senior executives’ incentive compensation arrangements with the senior risk officers to ensure that these arrangements do not encourage senior executives to take unnecessary and excessive risks that could threaten the value of the financial institution.

Second, the new rule requires the CEO to certify annually within 135 days after the financial institution’s fiscal year end that the financial institution and its compensation committee have complied with these executive compensation standards. Specifically, the principal executive officer of the financial institution is required to certify that the compensation committee has met at least once during the prior fiscal year with the senior risk officers of the financial institution to discuss and review the relationship between the risk management policies and practices of the financial institution and the SEO incentive compensation arrangements; the compensation committee has certified to this review; the financial institution has required that SEO bonus and incentive compensation be subject to recovery or “clawback” by the financial institution if the payments were based on materially inaccurate financial statements or any other materially inaccurate performance metric criteria; the financial institution has prohibited any golden parachute payment to a SEO; the financial institution has instituted procedures to limit the deduction for remuneration for federal income tax purposes to $500,000 for each SEO for the most recently ended fiscal year as if section 162(m)(5) of the Internal Revenue Code applied to the financial institution; and certain named individuals are the SEOs for the current fiscal year based on the compensation of such individuals during the prior fiscal year.

In addition to the certification required in the paragraph above, within 135 days of the completion of each annual fiscal year of the financial institution after the first fiscal year during any part of which the financial institution has participated in the CPP, the CEO of the financial institution is required to certify that the financial institution in fact has limited the deduction for remuneration for federal income tax purposes to $500,000 for each SEO for the fiscal year prior to the most recently ended fiscal year as if section 162(m)(5) of the Internal Revenue Code applied to the financial institution.

The CEO must provide the 120-day and annual certifications to the TARP Chief Compliance Officer. If the CEO is unable to provide any of these certifications in a timely manner, the CEO is required to provide the TARP Chief Compliance Officer an explanation of the reason such certification has not been provided. The new rule specifies the form of the required certifications.

The financial institution is also required to keep records to substantiate these certifications for at least six years following each certification and provide these records to the TARP Chief Compliance Officer upon request. For the first two years, the records must be kept in an easily accessible place.

The new rule also affirms that any individual or entity making or providing false information or certifications to the Treasury is subject to criminal penalties under federal criminal law.

Clarifications and Amendments to October 2008 Rules

The new rule also makes a few clarifications and a technical amendment to the October interim final rule.

The October rule required that the certification of the compensation committee of a financial institution whose securities are registered with the SEC regarding its review of incentive compensation arrangements of senior executive officers appear in the Compensation Discussion and Analysis required under the federal securities laws. The new rule requires that this certification appear in the Compensation Committee Report required pursuant to Section 407(e) of Regulation S-K. A financial institution that is a “smaller reporting company” for SEC reporting purposes, and which does not have a Compensation Committee Report in its proxy statement, should provide the certifications of the compensation committee to its primary regulatory agency.

The October rule requires that SEO bonus and incentive compensation paid during the period that the Treasury holds an equity or debt position acquired under the CPP be subject to recovery or “clawback” by the financial institution if the payments were based on materially inaccurate financial statements and any other materially inaccurate performance metric criteria. The new rule clarifies that the clawback requirement applies to SEO bonus and incentive compensation earned, but not paid, during the Treasury holding period.

New Guidance on Determination of Senior Executive Officers

Treasury also issued Frequently Asked Questions relating to the executive compensation standards to assist financial institutions’ compliance with these standards. The FAQs clarify that the SEOs for a year for the non-tax-related executive compensation standards are the “named executive officers” who are identified in the financial institution’s annual report on Form 10-K or annual meeting proxy statement for that year (reporting the executive’s compensation for the immediately preceding year). These executive officers are considered the SEOs throughout that entire year. For example, the SEOs for 2009 will be the named executive officers identified in the proxy statement filed in 2009. Prior to the identification of the named executive officers in the financial institution’s annual report on Form 10-K or annual meeting proxy statement, the financial institution must use its best efforts to identify the year’s SEOs.

The tax-related executive compensation standard requires financial institutions to agree not to claim a tax deduction for compensation paid to each SEO in an amount that exceeds $500,000. Because the contractual limitation on the amount of the tax deduction is based on current year compensation, the SEOs are determined based on compensation for that year, rather than compensation paid in the preceding year as described above. This means that for the purposes of the tax-related standard, SEOs for 2009 will be the named executive officers identified in the proxy statement filed in 2010.