Congress has taken the Obama Administration one step further by enacting some of the strictest executive compensation limits yet for financial institutions that receive federal assistance under the Trouble Assets Relief Program (“TARP”). The new rules were included in the economic stimulus legislation signed by President Obama on February 17, 2009, the American Recovery and Reinvestment Act of 2009 (the “ARRA”). Congressional action followed the issuance of tougher rules on executive pay by the Treasury Department on February 4, 2009 covering participants in future Treasury-sponsored assistance programs. Please see previous Kilpatrick Stockton alert from February 5, 2009.

But the public backlash over executive compensation practices at the highest profile recipients of federal aid drove Congress to insert new and considerably more onerous rules in the ARRA. The new restrictions under ARRA apply to all entities that have received or will receive financial assistance under TARP (“TARP-Recipients”), including participants in Treasury’s Capital Purchase Program. The new restrictions will continue to apply as long as any obligation under TARP remains outstanding. However, the new law does allow any TARP-Recipient to repay any government assistance (after consultation with the appropriate banking regulator) and, thereby, avoid the new limitations.

ARRA requires the Treasury Department to issue standards for TARP-Recipients that track the ARRA limits. However, it remains unclear whether and how the Treasury Department will revise its previous policies. For illustration, we have included some comparisons of the Treasury’s policies announced on February 4, 2009 with the new requirements under ARRA. In short, it remains unclear how the Treasury will reconcile the new rules under ARRA with its recently-announced policies on executive compensation. In any event, it is certain that additional rules and regulations will follow.

Under ARRA, TARP-Recipients must meet certain standards for executive compensation and corporate governance established by the Treasury, including the followings:

Overall Limit – Executive compensation programs for the top-five senior officers must exclude incentives that encourage the executives to take unnecessary risks that threaten the value of the institution.

Action Item – Institutions must continue to review and modify (to the extent necessary) existing compensation arrangements to ensure they do not provide incentives for taking unnecessary risk or threaten to the value of the institution.

Severance Payments - A prohibition on making any severance payment (i.e., a “golden parachute payment”) to one of the top-five senior executive officers or any of the next 5 most highly-compensated employees.

Compare the Treasury’s recently-announced policies, under which institutions receiving exceptional assistance in the future must eliminate any severance payment to the top-10 senior executives and limit severance payments for the next 25 senior executives to the equivalent of one year’s compensation. In the case of institutions that receive future assistance from a generally available program, severance payments for the top-5 senior executives must be limited to the equivalent of one year’s compensation.

Action Item – Institutions should review current severance and other benefits arrangements to determine the impact of this limitation on terminations occurring in the ordinary course of employment and in connection with a change in control.

Limit on Bonuses - A prohibition on paying (or accruing) any bonus, retention award or incentive compensation. However, this limit does not apply to the grant of restricted stock so long as the restricted stock (1) does not vest while the TARP assistance remains outstanding, (2) has a value that is not greater than 1/3 of the employee’s total annual compensation and (3) is subject to any other terms and conditions the Secretary of the Treasury may determine serves the public interest.

The scope of the limit on bonus payments varies by reference to the level of assistance received by the TARP-Recipient.

  • For institutions receiving $25 million or less – the limit applies to only the most highly compensated employee;
  • For institutions receiving between $25 million and $250 million – the limit applies to at least the 5 most highly compensated employees (but Treasury may increase this number);
  • For institutions receiving between $250 million and $500 million - the limit applies to the top-five senior officers and at least the next 10 most highly compensated employees; and

For institutions receiving $500 million or more – the limit applies to the top-five senior officers and at least the next 20 most highly compensated employees.

The new law does provide an exception for the payment of any bonus payment required pursuant to an employment contract executed on or before February 11, 2009.

Action Item – Institutions should begin considering how to use compliant forms of restricted stock grants in the overall compensation packages for senior executive officers and other highly compensated employees. Also, existing employment agreements should be viewed with counsel to determined whether a basis exists.

Recovery of Bonuses (Clawbacks) - A provision for the recovery of any bonus, retention award or incentive compensation paid to one of the top-five senior executive officers and any of the next 20 most highly-compensated employees based on statements of earnings, revenue, gains or other criteria that are later found to be materially inaccurate.

Compare the Treasury’s recently-announced policies, which also require institutions receiving exceptional assistance or participating in a generally available program in the future must “clawback” bonuses and incentive compensation from the top-25 executives if they are found to have knowingly engaged in providing inaccurate information relating to financial statements or performance metrics on which the bonuses or incentive compensation was based.

Anti-Manipulation - A prohibition on any compensation plan that would encourage manipulation of reported earnings to enhance the compensation of employees.

New Board Committee – TARP recipients must establish a board compensation committee, comprised entirely of independent directors, for the purpose of reviewing compensation plans. The committee must meet at least semi-annually to discuss and evaluate employee compensation plans relative to an assessment of any risk posed to the company as a result of the plans. If the TARP-Recipient is a non-SEC registrant and has received $25 million or less in assistance, these duties may be carried out by the entire board of directors.

Action Item – Institutions should begin exploring the establishment of this committee and the policies and procedures under which the committee operate.

CEO and CFO Certification of Compliance - The chief executive officer and the chief financial officer must provide a written certification of compliance with the new requirements. Public companies must file the certifications with the Securities and Exchange Commission with annual filings while non-public companies will file with the Secretary of the Treasury.

Action Item – This requirement expands the Treasury’s new policy requiring only the chief executive officer of any institution that has received or does receive government assistance to provide a written certification of compliance.

Luxury Expenditures - The board of directors must establish a company-wide policy regarding excessive or luxury expenditures (as identified by the Treasury), which may include entertainment or events, office and facility renovations and aviation or other transportation services.

Compare the Treasury’s recently-announced policies, which also require companies taking assistance in the future to adopt policies on luxury items.

Action Item – Institutions should review luxury items and perquisites available to executive officers and begin developing a policy with respect to these items. This review may include addressing items the institution is currently obligated to provide to an executive pursuant to an existing employment contract.

Shareholder Approval (Say-On-Pay) - Public companies must permit a non-binding shareholder vote to approve the compensation of executives at any shareholder meeting. The SEC must issues rules related to this provision by February 17, 2010.

Compare the Treasury’s recently-announced policies, which require institutions receiving exceptional assistance in the future to allow shareholders to nonbinding submit say-on-pay resolutions and institutions receiving future assistance under a generally available program to disclose the reasons that compensation arrangements of both senior officers and other employees do not encourage excessive and unnecessary risk taking.

Review of Prior Payments to Executives

The Secretary of the Treasury will review bonus and other compensation paid to the top-five senior executives and the next 20 most highly compensated employees of a TARP-Recipient before the enactment of ARRA to determine whether the payments were excessive or inconsistent with the purposes of ARRA or TARP or contrary to public interest. To the extent the Secretary or the Treasury finds these payments to be improper he will enter into a negotiation with the TARP-Recipient for appropriate reimbursements to the Federal Government.

Limits on Deductibility – The $500,000 annual limit on deductible compensation announced in the initial TARP rules applies to all TARP-Recipients. ARRA does not otherwise limit the amount of overall compensation that may be paid to an employee.

Compare the Treasury’s recently-announced policies, which require institutions receiving government assistance in the future to limit the overall compensation paid to the top-5 senior executives to $500,000 (with an exception for certain grants of restricted stock and with waivers possible for institutions participating in generally available programs.)