On Oct. 3, 2008, President Bush signed into law the Emergency Economic Stabilization Act of 2008 (the “Act”).1 Designed to promote liquidity in the financial markets and to minimize further economic deterioration in the United States, the Act authorizes the Secretary of the Department of Treasury (“Treasury” or the “Secretary”) to establish a troubled asset relief program (“TARP”) to purchase “troubled assets” from any “financial institution,” as those terms are defined in the Act. The following is a summary of some of the key provisions of the Act, including summaries of asset manager selection procedures and interim conflict of interest guidelines issued by Treasury on Oct. 6, 2008.

Financial Institutions Covered

Under the Act, the term “financial institution” means “any institution, including, but not limited to, any bank, savings association, credit union, security broker or dealer, or insurance company, established and regulated under the laws of the United States [or any state or U.S. jurisdiction] . . . having significant operations in the United States.” The Act does not specify what type of licensing or authorizations (e.g., state mortgage lending and broker licenses) would qualify an institution for purposes of inclusion in the definition of financial institution; however, we expect that Treasury will provide further clarification on this point in the Act’s implementing regulations, which Treasury is required to issue pursuant to the Act. The reference to “significant operations in the United States” is intended to address the inclusion of foreign entities (to the extent subject to federal or state regulation) in the definition; however, the “significant operations” standard is not further clarified under the Act.2 An institution owned by a foreign government is excluded from the Act’s definition of financial institution, but it is not clear what level of ownership triggers the exclusion. Foreign central banks are also excluded from the definition of financial institution.

Troubled Assets Covered

The term “troubled assets” under the Act includes residential and commercial mortgages and any securities or other instruments related to such mortgages originated or issued on or before March 14, 2008, the purchase of which the Secretary determines promotes “financial market stability.” In addition, troubled assets includes “any financial instrument” that the Secretary, after consultation with the Chairman of the Board of Governors of the Federal Reserve System, determines necessary “to promote financial market stability.” During recent Congressional hearings, Secretary Paulson indicated that TARP would first focus on the housing market and that the majority of funds would be directed to the housing market. Therefore it is currently unclear whether TARP will include purchases of other categories of financial assets, such as auto loans and leases, student loans and financial instruments related to such loans.

Troubled Asset Relief Program

The Program. Under the Act, the Secretary is immediately authorized to purchase $250 billion in troubled assets from financial institutions participating in TARP, but must issue formal regulations within the earlier of (a) two days after the first purchase under TARP and (b) Nov. 16, 2008. An additional $100 billion is available upon a Presidential certification of need. If more funding is needed after the $100 billion has been made available, an additional $350 billion is available if the President submits a written report to Congress detailing the Secretary's plan to exercise his authority and Congress does not withdraw approval for the increase. Treasury has until the end of 2009 to use the funds allocated for purchases under the Act.

The Act gives the Secretary authority to purchase troubled assets from financial institutions through direct purchases or through means involving market-based mechanisms, such as auctions and reverse auctions. Treasury is required under the Act to publish regulatory guidelines that must include the methods and mechanisms for pricing, valuing and purchasing troubled assets, subject to certain restrictions (for example, the Secretary must take “steps as may be necessary to prevent unjust enrichment of financial institutions participating in [TARP]”). The Act requires the Secretary to encourage the private sector to participate in purchases of troubled assets and to invest in financial institutions. We expect the implementing regulations issued by the Treasury to address such participation. The Act does not prohibit a financial institution from selling troubled assets that it itself purchased, but the Act prohibits the sale of a troubled asset to the Secretary at a higher price than what the seller paid to purchase the asset.

In general, in purchasing troubled assets under TARP, the Secretary is required to consider various factors, including protecting the interests of taxpayers, providing stability to financial markets, helping families keep their homes, protecting certain retirement plans and providing financial assistance to small financial institutions in underserved or low- to moderate-income communities whose capital suffered as a result of the takeovers of Fannie Mae and Freddie Mac. In a direct purchase from a financial institution, the Secretary must also take into consideration “the long-term viability of the financial institution” as part of the determination as to whether such purchase would make efficient use of Treasury funds.

Use of Service Providers. The implementation of TARP permits the Treasury to use service providers, such as asset managers. Typically, the government is subject to the Federal Acquisition Regulation (“FAR”)3 when contracting with service providers, however the Act permits the Secretary to waive specific provisions of the FAR if “urgent and compelling circumstances make compliance with such provisions contrary to the public interest.” The Act also requires the Secretary to publish guidelines that include procedures for selecting asset managers and to manage or prohibit conflicts of interest in the administration of TARP, such as conflicts arising in the selection or hiring of contractors or advisors, including asset managers. The Treasury released such procedures on Oct. 6, 2008, and a summary of those procedures is provided at the end of this Alert.

Purchase Authority for Warrants and Debt Instruments. The Act generally requires that Treasury receive non-voting warrants from publicly traded financial institutions or non-voting warrants or senior debt obligations from non-public financial institutions in connection with direct purchases or auction purchases by the Secretary under TARP in order to allow taxpayers to share in equity appreciation and to cover losses and expenses in connection with TARP. The Secretary is also required to establish appropriate alternative requirements for any participating financial institution that is legally prohibited from issuing securities and debt instruments to prohibit circumvention of these requirements.

Corporate Governance Requirement for Direct Sellers. Where troubled assets are sold through direct purchases where no bidding process or market prices are available and the Secretary “receives a meaningful equity or debt position in the financial institution as a result of the transactions,” the Secretary must require that the financial institution meet appropriate standards for corporate governance for the duration of the holding by the Secretary of the equity or debt position. It is unclear what the Treasury will consider to be appropriate standards for corporate governance, but the Treasury’s implementing regulations may provide further clarification.

Protection for Homeowners. For mortgages and mortgage-backed securities acquired through TARP, the Secretary must implement a plan to mitigate foreclosures by maximizing assistance to homeowners and encouraging servicers of the underlying mortgages to modify loans through programs, such as the HOPE for Homeowners Program, which provides homeowners engaged in efforts to avoid foreclosure with the opportunity to refinance their mortgages (if the lender agrees to write down a portion of their mortgage) into more affordable fixed rate loans. The Act also allows the Secretary to use loan guarantees and credit enhancements to facilitate loan modifications to prevent avoidable foreclosures and requires the Secretary to coordinate with other federal entities that hold troubled assets in order to identify opportunities to modify loans, considering net present value to taxpayers. In addition, the Act requires federal entities that hold mortgages and mortgage-backed securities, including the Federal Housing Finance Agency, the Federal Deposit Insurance Corporation (the “FDIC”), and the Federal Reserve Board, to develop plans to minimize foreclosures and to work with servicers to encourage loan modifications, considering net present value to taxpayers.

Limits on Executive Compensation. The Act imposes limitations on the compensation of executives at financial institutions that sell troubled assets to the Treasury by participating in TARP. The limitations differ depending on whether the financial institution sold troubled assets to the government through a direct purchase or an auction purchase. These limitations apply to senior executive officers, defined generally as one of the institution’s five highest-paid executives.

Where troubled assets are sold through direct purchases where no bidding process or market prices are available and the Secretary “receives a meaningful equity or debt position in the financial institution as a result of the transactions,” the Secretary must require that the financial institution meet standards for executive compensation to senior executive officers for the duration of the holding by the Secretary of the equity or debt position. Such standards include limitations on incentives for senior executive officers that encourage excessive risk taking, clawbacks on any bonus or incentive compensation based on materially inaccurate statements of earnings, gains or other criteria, and a prohibition on making any golden parachute payments. Where troubled assets are sold through auction purchases and the aggregate purchases (including direct purchases) exceed $300 million, certain provisions apply to senior executive officers, including a prohibition on golden parachute payments under new contracts in the event of an involuntary termination, bankruptcy filing, insolvency or receivership, restrictions on the tax deductibility of executive remuneration, as defined in the Act, in excess of $500,000 and an expansion of the application of the current golden parachute tax regime with respect to current agreements.

Insurance of Troubled Assets

If the Secretary implements TARP, the Act also requires the Secretary to establish a separate program to guarantee troubled assets of financial institutions. The Act requires that Treasury establish a Troubled Assets Insurance Financing Fund (the “Fund”) that will consist of risk-based premiums collected from financial institutions that participate in the guarantee program. The Fund will be used to fulfill the participating financial institutions’ obligations under the guarantees. Participation is available at the option of the financial institution.


The Act establishes two oversight boards to review the Secretary’s authority under the Act: the Financial Stability Oversight Board and the Congressional Oversight Panel. In addition, the Act establishes the Office of the Special Inspector General for Troubled Asset Relief Program to conduct, supervise and coordinate audits and investigations of the actions undertaken by the Secretary under the Act.

Authority to Suspend Mark-to-Market Accounting Standards

The Act gives authority to the Securities and Exchange Commission to suspend mark-to-market accounting standards (to the extent such action is in the public interest and consistent with investor protection) for any individual financial institution or with respect to any class or category of transactions, and commissions a study on the impact of the mark-to-market accounting standard.

Temporary Increase in FDIC Insurance

Pursuant to Section 136 of the Act, FDIC deposit insurance will be temporarily increased from $100,000 to $250,000 until Dec. 31, 2009. To fund the increase, the Act grants the FDIC unlimited borrowing access from the Treasury, but prohibits the FDIC from using the higher coverage as a factor in setting the assessments of insured depository institutions.

Tax Relief Provisions

For Financial Institutions. Under Section 301 of the Act, any gains or losses on sales or exchanges of Fannie Mae and Freddie Mac preferred stock owned on Sept. 6, 2008, or sold or exchanged on or after Jan. 1, 2008, and before Sept. 7, 2008, by certain financial institutions will be treated as ordinary income or losses. The provision, specifically in respect of the character of loss, is designed to allow banks to obtain the tax benefit of the loss on the preferred stock and is intended to reduce any need by such banks to obtain additional capital and to prevent some community banks from becoming insolvent.

For Homeowners. The Act provides assistance to homeowners in the form of tax relief. Section 303 of the Act excludes qualified principal residence debt that is canceled in foreclosure or through a write-down from taxable income. However, such relief is not extended to home equity loans. This tax relief is extended through the end of 2012.

Asset Manager Selection Procedures

On Oct. 6, 2008, Treasury released the procedures that it would follow in selecting asset managers for the portfolio of troubled assets purchased under TARP. Treasury will select asset managers of securities separately from asset managers of mortgage whole loans. In each case these procedures will apply.

Asset managers will be financial agents of the United States, and not contractors. As financial agents, they will have a fiduciary agent-principal relationship with Treasury, with a responsibility for protecting the interests of the United States. Financial institutions are eligible to be designated as financial agents of the United States.

According to the published procedures:

First Phase. Prospective financial agents will be solicited through the issuance of a public notice, posted on the Treasury website, requesting that interested and qualified financial institutions submit a response. The notice will describe the asset management services sought by Treasury, set forth the rules for submitting a response, and list the factors that will be considered in selecting financial institutions. The notice will also include minimum qualifications, such as years of experience and minimum assets under management, and eligibility requirements, such as a clean audit opinion. Treasury will release one notice for securities asset managers, and a separate notice for whole loan asset managers.

Treasury posted today three notices for financial agents to provide services related to TARP. The three services being sought, and the internet links where the applicable notices may be found, are:

• Custodian, Accounting, Auction Management, and Other Infrastructure Services: http://www.treas.gov/initiatives/eesa/docs/notice_custodian-services.pdf  

• Securities Asset Management Services: http://www.treas.gov/initiatives/eesa/docs/notice_securities-asset-mgr.pdf  

• Whole Loan Asset Management Services: http://www.treas.gov/initiatives/eesa/docs/notice_whole-loan-asset-mgr.pdf  

The notices require responses to be submitted no later than 5 p.m. on Wednesday, Oct. 8, 2008.

Second Phase. Treasury will evaluate the initial responses from all interested and qualified financial institutions, and will invite certain candidates to continue to the second phase of the financial agent selection process. This second phase, and subsequent phases, may be conducted under confidentiality agreements to facilitate information exchange, but consistent with the public disclosure and transparency provisions of the Act. In the second phase, the prospective financial agents will provide additional information about their expertise, as well as asset management strategies, risk management, and performance measurement. This phase may include telephone conversations to allow questioning by and of Treasury.

Final Phase. Treasury will evaluate the responses from the second-phase candidates, and will determine whether a candidate will continue to be considered. In this last stage, a financial institution may be required to conduct face-to-face discussions on portfolio scenarios, public policy goals and statutory requirements, and to respond to interview questions to assess the capabilities of prospective individuals to be assigned to manage assets. Following any face-to-face meetings, Treasury will make final selections of the financial institutions to be designated as asset managers.

Financial institutions selected to be asset managers must sign a Financial Agency Agreement with Treasury, a copy of which will be provided for review during the second stage of the selection process. The financial institution’s willingness to enter into the standard Financial Agency Agreement, with the established terms and conditions currently applied to financial agents of the United States, will be among the factors used in evaluating the financial institution.

At each stage in the selection process, personnel from the Offices of the Fiscal Assistant Secretary and the Assistant Secretary for Financial Markets, and possibly additional personnel within the Offices of Domestic Finance and Economic Policy, will evaluate the candidate submissions and make recommendations to the head of the Office of Financial Stability, who will make the final decision.

Treasury expects to designate multiple asset managers. However, Treasury, in its discretion, may not select all asset managers at the same time, but rather in some sequence that matches Treasury’s asset-acquisition schedule and project plan for the portfolio. As business requirements evolve, Treasury may issue additional notices in the future to select more asset managers, consistent with the process described above.

Treasury will issue separate notices, consistent with these procedures, specifically to identify smaller and minority-owned and women-owned financial institutions that do not meet the minimum qualifications for current assets under management in the initial notices. Such financial institutions will be designated as sub-managers within the portfolio. The selection process for asset managers may involve extremely short deadlines for submitting information and for traveling to Washington, D.C. for meetings or interviews. Treasury will not reimburse or otherwise compensate a prospective asset manager for expenses or losses incurred in connection with the selection process.

Interim Guidelines for Conflicts of Interest

On Oct. 6, 2008, Treasury also issued its interim guidelines for potential conflicts of interest related to the authorities granted under the Act. The interim guidelines outline the process for reviewing and addressing actual or potential conflicts of interest among contractors performing services in connection with the Act. The interim guidelines will remain in effect until final guidelines are developed.

Treasury cites the following types of conflicts of interest in the interim guidelines as examples of conflicts which they propose to address with the guidelines:

  • Impaired Objectivity. This conflict of interest occurs when a contractor's judgment or objectivity may be impaired due to the fact that the substance of the contractor's performance has the potential to affect other interests of the contractor.
  • Non-Public Information. This conflict of interest occurs when a contractor obtains access to sensitive,  non-public information (belonging to Treasury or to third parties) while performing the contract.
  • Personal Conflicts of Interest. Because contractor employees are not always subject to the same ethical restrictions that are imposed by law on federal government employees, contracts with Treasury may create a potential for personal conflicts of interest involving individual employees of a contractor.

To address conflicts of interest, the interim guidelines state that Treasury officials should adhere to the following guidelines for addressing conflicts of interest arising with contractors under TARP:

  • Where appropriate, Treasury may obtain non-disclosure agreements (which may include restrictions on the dissemination of information within the contractor's organization) and conflict of interest agreements in advance of supplying an offeror a solicitation.
  • The solicitation should instruct prospective offerors that they must disclose any actual or potential conflicts of interest (including those associated with an affiliate, consultant, or subcontractor) which could arise from performance of the contract. The solicitation will indicate that, if actual or potential conflicts of interest are identified, the prospective offeror must submit a mitigation plan as part of its initial proposal. In some situations, Treasury may also desire to include provisions requiring that the prospective offeror identify personal conflicts of interest among employees who would be performing the work, and include measures in its mitigation plan for addressing such personal conflicts of interest.
  • The solicitation should include an evaluation factor or criteria whereby Treasury will assess the likely effectiveness of the proposed conflict of interest mitigation plan.
  • The solicitation will identify any minimum requirements or standards for the conflict of interest mitigation plan.
  • If the contractor will owe a fiduciary duty to Treasury in performing the contract, the solicitation should include a statement to that effect. This provision will become part of the resulting contract.
  • The solicitation should include non-disclosure provisions which, at a minimum, apply to the prime contractor. In some situations, Treasury may also desire to include provisions requiring that the prime contractor obtain comparable non-disclosure and/or conflict of interest agreements from subcontractors or individual employees.
  • The solicitation should state that Treasury will oversee and enforce the proposed mitigation plan as part of the contract.
  • The Treasury Senior Procurement Executive will review and approve all provisions related to conflicts of interest prior to issuance of the solicitation.
  • The solicitation should require that mitigation plans be submitted with offerors' initial proposals. Treasury's evaluators, source selection personnel, and legal counsel will examine the proposed mitigation plans to determine the extent to which those plans provide sufficient protection against actual or potential conflicts of interest.
  • The severity of a conflict of interest is necessarily dependent upon the circumstances of the case and the nature of the contractual action. Treasury personnel should not assume that a mitigation plan which is acceptable under one situation would also be acceptable under different circumstances.
  • The contracting officer may negotiate the mitigation plan with the offeror, taking into account the type of procurement being conducted.
  • Notwithstanding the submission of a mitigation plan, it is possible that contractor conflicts of interest may exist which cannot be effectively neutralized or mitigated. An offeror with an unacceptable mitigation plan will not be eligible for award unless conflicts are waived by the agency head or a designee.
  • It is possible that a conflict of interest may be waived by the agency head or a designee.
  • Upon award of the contract, the successful offeror's mitigation plan will be formally incorporated into the contract, making the mitigation plan a contractually binding obligation.