Yesterday, Treasury published an interim final rule (the “Rule”) that provides long-awaited guidance on the executive compensation and corporate governance standards imposed by the Emergency Economic Stabilization Act of 2008 (“EESA”), as amended by the American Recovery and Reinvestment Act of 2009 (“ARRA”). For more information on ARRA, please refer to our previous alert “Congress Sets New Executive Compensation Limits for TARP Recipients.” On June 10, 2009, Treasury released a statement on compensation that sets forth five principles that are intended to be the basis for future guidelines to which all public companies, particularly financial institutions, would be subject. Treasury also released two fact sheets that anticipate proposed legislation on "say-on-pay" and compensation committee independence.  

This alert outlines the Rule and announcements, and is divided into four sections, as follows: (i) new guidance on preexisting ARRA provisions, (ii) new compensation and governance standards added by the Rule, (iii) the creation of the Office of the Special Master for TARP and (iv) the compensation principles and legislative proposals recently announced by Treasury.  

Key highlights of the Rule include:  

  • A definition of “financial assistance” under the Troubled Asset Relief Program (“TARP”) provides flexibility to structure investment funds under the Public-Private Investment Program (“PPIP”) so that general partners and investment managers to those investment funds may be able to avoid the application of the TARP restrictions. Furthermore, the Rule indicates that a Term Asset-Backed Loan Facility (“TALF”) borrower will not be deemed to have received “financial assistance” and therefore will also not be subject to the TARP restrictions.  
  • A clarification of the definition of “highly compensated employees” to encompass employees that may not be executive officers and to specify how compensation should be calculated for this purpose.  
  • An exception from the limitations on bonuses to certain commission payments, including for investment management services.  
  • An expansion of ARRA’s prohibition on golden parachute payments and a new prohibition on tax grossups.
  • The creation of the Office of the Special Master for TARP, with unprecedented new powers to intervene in compensation decisions at certain financial institutions.  
  • Anti-abuse measures to limit the avoidance of the executive compensation restrictions.  
  1. Guidance on ARRA Provisions

The Rule applies to all entities that have or will receive financial assistance under TARP (“TARP recipients”), as well as any entity within a TARP recipient’s parent-subsidiary controlled group (using a 50% ownership test). The restrictions generally apply for the period in which any obligation arising from financial assistance under TARP remains outstanding (the “TARP Period”), not including any period in which the government holds only warrants to purchase the common stock of the TARP recipient. Thus, financial institutions that have repaid their TARP assistance will generally no longer be subject to the Rule. The definition of “financial assistance” allows flexibility to structure investment funds under PPIP so that general partners and investment managers to those vehicles may be able to avoid the TARP restrictions. Also, a Term Asset- Backed Loan Facility (“TALF”) borrower will not be deemed to have received “financial assistance” and therefore will also not be subject to the TARP restrictions.  

The restrictions on compensation, including bonus limitations, golden parachute payments, and clawbacks, as described below, generally apply to the TARP recipient's senior executive officers (the principal executive officer, principal financial officer and the next three most highly compensated executives, as determined in accordance with the Security and Exchange Commission’s (the “SEC”) proxy rules, which are applied by analogy for private issuers) (“SEOs”) and, depending on the particular provision, certain other of the TARP recipient's most highly compensated employees. The Rule clarifies that highly compensated employees are identified based on compensation paid to the employees in the TARP recipient's prior fiscal year. Compensation for this purpose is determined by reference to the SEC's proxy rules rather than, for example, an employee's taxable income. The Rule became generally effective yesterday, but is open to public comment until August 14, 2009. See the attached Addendum for a chart that provides a brief overview of the effective periods for prior enactments and guidance.  

Bonus Limitations  

TARP recipients are prohibited from paying or accruing any bonus, retention award or incentive compensation generally to between one and twenty-five of the TARP recipient's most highly compensated employees, depending on the outstanding amount of financial assistance the TARP recipient has received. TARP recipients are permitted, however, to award long-term restricted stock or stock units, as long as the value of the restricted stock or units is no greater than one-third of the employee’s annual compensation and the award does not fully vest until the repayment of all financial assistance by the TARP recipient. The Rule clarifies that for each 25% of total financial assistance repaid by the TARP recipient, 25% of the restricted stock may become transferable or units may become payable, although the employee must also continue to be an employee of the TARP recipient for at least two years after the grant date.  

These bonus limitations do not apply to any payment required to be paid under a valid employment contract executed on or before February 11, 2009 if the employee has a legally binding right to the payment and the payment is made in accordance with the terms of the contract as of February 11, 2009. Treasury’s interpretation of the term “employment contract” would include bonuses pursuant to broad-based employee plans, such as equity incentive compensation plans, if the employee has a legally binding right to the bonus as of February 11, 2009. Importantly, certain commission compensation, including for investment management services to unrelated parties, is also excluded from the bonus restrictions.

Golden Parachute Payments  

TARP recipients are prohibited from making golden parachute payments to an SEO or the next five most highly compensated employees. Golden parachute payments include a payment for the employee’s departure from a TARP recipient for any reason (excluding death or disability) and amounts received upon a change in control of the TARP recipient, with certain limited exceptions including payments for services rendered or benefits accrued, certain payments from qualified retirement plans, foreign retirement plans and severance or similar payments required under state or foreign law. The value of accelerated vesting due to a departure or a change in control is also considered a prohibited golden parachute payment. Golden parachute payments are treated as paid upon departure, so employees cannot attempt to bypass these rules by deferring payment beyond the expiration of the TARP period. Furthermore, this restriction applies even if a golden parachute payment is pursuant to an agreement entered into before the TARP period and there is no exclusion for payments that would otherwise be exempt from excise tax because the amount of the payment does not exceed an employee’s safe harbor amount under the existing tax rules related to golden parachute payments.  


Any bonus, retention award or incentive compensation paid to or accrued on behalf of an SEO or the next twenty most highly compensated employees is subject to a clawback if the payments or accruals were based on materially inaccurate financial statements or performance metric criteria. If the material inaccuracy is discovered after the end of the TARP period, the compensation is still subject to a clawback.  

Compensation Committees  

Before the later of 90 days after closing an agreement with Treasury or September 14, 2009, most TARP recipients must establish a compensation committee composed of independent members of the board of directors. Most public companies already maintain independent compensation committees pursuant to stock exchange listing standards and would not need to reformulate their compensation committee.  

Under the Rule, the TARP recipient’s compensation committee is required to meet at least every six months with senior risk officers to evaluate and review SEO and employee compensation plans and to focus on the risks these plans pose to the TARP recipient, such as the compensation features that could lead the TARP recipient and its SEOs to take unnecessary and excessive risks or which encourage short-term results rather than long-term value creation. The compensation committee also has the duty to identify and eliminate features of compensation plans that encourage the manipulation of reported earnings. Annually, the compensation committee must certify it has completed its review of the compensation plans and provide a narrative description of how it limited these undesirable plan features. For public companies with registered securities, these certifications and disclosures are to be included in the Compensation Committee Report section of their proxy statement (or provided to the company’s primary regulator if the TARP recipient is a smaller reporting company or does not have registered securities).  

  1. New Compensation and Governance Standards

In addition to guidance on existing ARRA provisions, the Rule also expands ARRA by formulating new compensation and governance standards discussed below.  

Perquisite and Compensation Consultant Disclosure Requirements  

The Rule imposes annual disclosure requirements on TARP recipients regarding the provision of perquisites to certain employees and the engagement of compensation consultants by a TARP recipient, its compensation committee or its board. For perquisites with a value exceeding $25,000 annually that are provided to SEOs and certain other highly compensated employees, the TARP recipient must provide to Treasury and its primary regulatory agency a narrative description of the amount and nature of the perquisites, the recipients and a justification for offering perquisites. Also on an annual basis, the compensation committee must provide a narrative description of whether the board, compensation committee or TARP recipient has engaged a compensation consultant. The disclosure must describe the types of services the compensation consultant, or any of its affiliates, has provided to the board, compensation committee or TARP recipient during the prior three-year period.  

Prohibition on Tax Gross-Up Payments  

During the TARP period, TARP recipients are also prohibited from providing tax gross-ups (or promises to provide tax gross-ups at any point in the future, including after the TARP period ends) to any of the SEOs and next twenty most highly compensated employees. Tax gross-ups generally include any reimbursement of taxes owed with respect to any compensation, but exclude certain tax equalization payments for employees in foreign jurisdictions.  

Excessive or Luxury Expenditures Policy Requirement  

Boards of directors of TARP recipients are required to have in place a policy on excessive and luxury expenditures, which includes expenditures related to entertainment, events, office and facility renovations and other similar expenditures. The Rule requires that the TARP recipient provide this policy (and any amendments) to Treasury and its primary regulatory agency and post the policy on its website.  


TARP recipients must permit a separate, non-binding, shareholder vote to approve the compensation of executives (commonly known as "say-on-pay") as disclosed in its annual proxy statement. To be in compliance with this rule, a TARP recipient will need to comply with any applicable guidance promulgated by the SEC. Treasury has also released a legislative proposal on say-on-pay, which is discussed below.  

Certification Requirements  

The Rule requires that the CEO and CFO of a TARP recipient provide a written certification of compliance with its requirements to the SEC or, for non-public entities, to Treasury within 90 days of the end of the TARP recipient’s fiscal year. The Rule provides two model certifications: one that applies for the TARP recipient’s first fiscal year in the TARP period and another that applies for subsequent years. The certifications are required to be filed with the TARP recipient’s Form 10-K (or, for private companies, with its primary regulatory agency) and Treasury.  

Special Rule for Mergers and Acquisitions  

The Rule also addresses the application of the compensation restrictions in the context of mergers and acquisitions involving TARP recipients. Specifically, an entity unrelated to a TARP recipient will not become subject to the restrictions merely due to the acquisition of a TARP recipient. Provided the acquirer is not itself a TARP recipient, employees of the target TARP recipient who become employees of the acquirer will no longer be subject to the TARP restrictions. However, if the primary purpose of a transaction is to evade the restrictions, then the acquirer will be treated as a TARP recipient upon the acquisition.

  1. Creation of the Office of the Special Master for TARP

The Rule establishes the Office for the Special Master for TARP, to be headed by Kenneth Feinberg. The Special Master’s authority includes administering the TARP executive compensation and corporate governance provisions, providing guidance and making determinations as to whether companies have complied with the Rule.  

Employees of TARP Recipients Receiving “Exceptional Financial Assistance”  

The Special Master has the authority to determine whether the compensation structure for each SEO or highly compensated employee of a TARP recipient receiving exceptional assistance will or could result in payments that are inconsistent with the purposes of TARP or are otherwise contrary to the public interest, to make determinations with respect to the application of the bonus limitations to TARP recipients and to rule with respect to the actual amounts that are payable to the executives. The Special Master also has the authority to require that the compensation arrangements be altered to meet the standards set forth in the Rule.  

Review of Prior Payments and Advisory Opinions  

The Special Master also has the responsibility for administering the provisions in EESA relating to the review of bonuses, retention awards and other compensation that was paid before February 17, 2009 to employees of TARP recipients in order to determine whether any payments were inconsistent with the purposes of TARP or otherwise contrary to the public interest. TARP recipients or their employees may request an advisory opinion from the Special Master as to whether a particular compensation structure could result in payments that are inconsistent with the purposes of TARP or otherwise contrary to the public interest. In addition, the Special Master has the authority to render advisory opinions on its own initiative. If the Special Master finds that any payments are inconsistent with TARP based on its review, or issues an adverse opinion to this effect, the Special Master may negotiate with the TARP recipient and the relevant employee regarding appropriate reimbursements to the TARP recipient or the government.  

  1. Treasury Announcement and Legislative Proposals

On June 10, 2009, Treasury released a statement on compensation that set forth five broad-based principles designed to better align compensation practices with sound risk management and long-term growth. These five compensation principles set forth in the Treasury announcement are meant to be the foundation for future reforms and are intended to apply “particularly” to the financial sector (leaving open their wider application to all public companies in the future), regardless of whether the entities are TARP recipients. In conjunction with the Treasury announcement, two legislative proposals were released concerning “say-onpay” and compensation committee independence at public companies.  

Treasury Statement on Compensation  

In a statement, Treasury Secretary Timothy Geithner made clear that there is no intention to create pay caps or to prescribe how companies must set compensation. Rather, Treasury indicates these standards are intended to guide compensation practices towards prudent risk-taking and properly aligned incentives. Listed below are the five principles set forth by Treasury:  

  1. Compensation plans should properly measure and reward performance.
  2. Compensation should be structured to account for the time horizon of risks.
  3. Compensation practices should be aligned with sound risk management.
  4. Golden parachutes and supplemental retirement packages should align the interests of executives and shareholders.
  5. Transparency and accountability in the process of setting compensation should be promoted.  

Proposed Say-on-Pay Legislation Fact Sheet  

The Obama administration, with Treasury’s support, is calling for legislation that would give the SEC the authority to require public companies to give shareholders a non-binding say-on-pay vote. All public companies would be required to include a say-on-pay shareholder resolution in their annual proxy statement, which would solicit the approval or disapproval of the issuer's executive compensation program as disclosed in the proxy. Under the proposal, shareholders would vote on the entire compensation program without the ability to identify the specific practices of which shareholders may disapprove. In partial response to this lack of granularity, companies will have the ability, if they desire, to include additional resolutions on specific compensation decisions. Shareholders will also have the ability to cast a non-binding say-on-pay vote for golden parachute compensation disclosed in proxy material prepared in connection with a merger, acquisition or any other transaction that may involve a change in control.  

Proposed Compensation Committee Legislation Fact Sheet

Treasury is also asking for Congressional approval of legislation that would give compensation committees greater independence, similar to the independence granted to audit committees after the passage of the Sarbanes-Oxley Act of 2002. The compensation committees of companies listed on national securities exchanges would have to meet “exacting” standards for independence promulgated by the SEC. Furthermore, compensation committee members would have to be independent from management, as determined by standards also promulgated by the SEC, and companies would be required to ensure that compensation committees have the resources to hire independent compensation consultants and outside counsel answerable solely to the compensation committee.  


The Rule clarifies both the provisions of ARRA and the intentions of the Obama administration. Controversial proposals, such as the $500,000 salary cap previously proposed by the administration, have largely been abandoned. Risk avoidance and long-term value seem to underlie both the Rule and the other Treasury announcements and legislative proposals. It remains to be seen whether future events or Congressional action will take these executive compensation and corporate governance standards in new directions.