Yesterday, the Treasury Department issued its newest restrictions and proposals related to executive compensation. While there was almost immediate and ubiquitous press coverage, we are providing in this Update a brief guide to the new restrictions.
The newest restrictions issued by Treasury yesterday essentially divide the world of Troubled Assets Relief Program (TARP) recipients into two groups:
- Those receiving government aid under “exceptional assistance.” Restrictions issued for these companies are effective immediately.
- Those receiving government aid under “generally available programs.” For these companies Treasury issued proposed guidance relating to future generally available capital access programs, and this proposal is subject to public comment.
“Generally available programs” have the same terms for all recipients, with limits on the amount each institution may receive and specified returns for taxpayers. The Capital Purchase Program, or CPP, is an example of a generally available program. However, most of the new standards will not apply retroactively to existing programs such as the Capital Purchase Program and the Term Asset-Backed Securities Loan Facility.
Firm’s receiving more assistance than is allowed under a widely available standard are receiving “exceptional assistance.” This type of aid is provided under specifically negotiated agreements with Treasury. Examples of exceptional assistance include arrangements with AIG, Bank of America, and Citibank.
Do not assume that Treasury’s announcement yesterday is the end of the story. The restrictions for generally available programs are forward-looking proposals, subject to public comment. The Treasury also issued preliminary thoughts on long-term regulatory reform of compensation policies (also discussed in this Update, below). Lastly, although certainly not finally, Senators Ron Wyden (D-Ore.) and Olympia Snowe (R-Maine) have filed an amendment to the stimulus bill now being debated in the Senate which would require that financial institutions that receive funds under TARP to either repay the cash portion of any bonus paid to employees in excess of $100,000 within 120 days of enactment, or face a 35 percent excise tax on what is not immediately repaid.
PROVISIONS APPLICABLE TO ALL COMPANIES RECEIVING GOVERNMENT ASSISTANCE, INCLUDING COMPANIES ALREADY FUNDED UNDER CPP
- The chief executive officers of all financial institutions that receive any form of TARP funding must provide a certification that the institution has “strictly complied” with statutory, Treasury, and contractual executive compensation restrictions. Recertification is required annually.
- The compensation committee at each financial institution receiving TARP funds must provide an explanation of how senior executive compensation arrangements do not encourage excessive and unnecessary risk-taking.
These provisions apply to those financial institutions that already have received TARP funds as well as those seeking future funding.
PROVISIONS APPLICABLE TO FUTURE RECIPIENTS OF EXCEPTIONAL FINANCIAL ASSISTANCE
- The total amount of annual compensation for each senior executive officer is capped at $500,000, not including grants of restricted stock awards. Under the previous rules, pay in excess of these limits was permitted, but was not deductible for tax purposes.
- Pay to senior executives beyond $500,000 must be made in restricted stock or other similar long-term incentive arrangements. The senior executive receiving such restricted stock will only be able to recognize income either (i) after the government has been repaid (including the contractual dividend payments that ensure taxpayers are compensated for the time value of their money) or (ii) after a specified period according to conditions that consider, among other factors, the degree to which the company has satisfied repayment obligations, protected taxpayer interests, or met lending and stability standards.
- The senior executive compensation structure and the rationale for how compensation is tied to sound risk management must be submitted to a non-binding shareholder resolution (similar to so-called “say on pay” proposals).
- While financial institutions receiving government aid are already required to implement provisions to clawback bonuses and incentive compensation from their top five senior executives if any of the criteria on which such compensation is based is later found to have been materially inaccurate, the institutions must now implement provisions to clawback bonuses and incentive compensation from any of the next 20 senior executives if they are found to have knowingly engaged in providing inaccurate information relating to financial statements or performance metrics used to calculate their own incentive pay.
- The financial institutions must implement provisions to ban the top 10 senior executives from receiving any golden parachute payment upon severance from employment. In addition, and “at a minimum,” the next 25 executives must be prohibited from receiving any golden parachute payment greater than one year's compensation upon severance from employment.
- The Board of Directors must adopt a company-wide policy related to “luxury expenditures” which are any expenditures related to aviation services, office, and facility renovations; entertainment and holiday parties; and conferences and events. This policy is not intended to cover reasonable expenditures for sales conferences, staff development, reasonable performance incentives, and other measures tied to a company's normal business operations. The expenditures policy will need to be posted on the company web site, and the chief executive officer of such company would be required to make determinations regarding and certify the compliance of expenditures that could be viewed as excessive or luxury items.
PROVISIONS INTENDED TO APPLY TO FUTURE PARTICIPANTS IN GENERALLY AVAILABLE PROGRAMS
As noted above, these new standards will not apply retroactively to existing investments or to programs already announced such as the Capital Purchase Program and the Term Asset-Backed Securities Loan Facility. The Treasury intends to issue the following executive compensation requirements, subject to public comment, relating to future generally available capital access programs.
- Limit Senior Executives Officers to $500,000 in total annual compensation, plus restricted stock, unless waived with full public disclosure (a so-called a non-binding "say on pay" shareholder resolution).
- Apply the same clawback provision to the top 25 senior executives in the same manner as applies to companies receiving exceptional assistance.
- Upon a severance from employment, the top five senior executives will not be allowed a golden parachute payment greater than one year's compensation (as opposed to three years under the current TARP Guidelines).
- Apply the same requirement for Board of Directors' adoption of Company policy regarding approval of luxury expenditures.
LONG TERM REGULATORY REFORM OF COMPENSATION POLICIES
The Treasury also issued the following three proposals as the basis of long-term reform of company-wide compensation strategies at financial institutions:
- Require compensation committees of all public financial institutions to review and disclose strategies for aligning compensation with sound risk-management.
- Compensation of top executives should include incentives that encourage a longterm perspective. For example, this could include requiring top executives at financial institutions being required to hold stock for several years after it is awarded. These so-called “hold until retirement” provisions are intended to encourage a more longterm focus on the economic interests of the company.
- Shareholders of financial institutions should have the opportunity to vote on a nonbinding resolution on both the levels of executive compensation as well as how the structure of compensation incentives helps to promote risk management and longterm value creation for the company and the economy as a whole