The guidance applies to all public companies, including those that participate in TARP.

The U.S. Department of the Treasury and the Securities and Exchange Commission (SEC) recently announced several initiatives that affect all public companies regardless of whether they participate in the Troubled Asset Relief Program (TARP) under the Emergency Economic Stabilization Act of 2008 (EESA) as modified by the American Recovery and Reinvestment Act of 2009 (Recovery Act).

Treasury Department Guidance Applicable to All Public Companies

On June 10, 2009, Treasury Department Secretary Geithner delivered a speech where he indicated the administration’s desire to “better align compensation practices—particularly in the financial sector?with sound risk management and long-term growth.”  To that end, Secretary Geithner identified five broad-based principles:

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

Based on these five broad-based principles, Secretary Geithner indicated that the administration intended to work with Congress to pass legislation in the following two specific areas:

  • Shareholder "Say on Pay" – The administration called for legislation giving the SEC authority to require companies to give shareholders a non-binding vote on executive compensation packages.  (As discussed in a previous McDermott Will & Emery White Paper, the Recovery Act requires each TARP recipient to provide shareholders an advisory, non-binding vote on executive compensation.)  According to the Treasury Department’s Fact Sheet, the non-binding shareholder vote would permit shareholders to vote not only on the annual compensation (salary, bonus and other compensation) of the company’s top five executives, but also on change in control/golden parachute payments.  It is widely anticipated that the administration will be successful in having Congress enact Say on Pay legislation for all public companies later this year.  Public companies should begin to consider changes for next year’s proxy in light of Say on Pay, including the structure of advisory votes and how to manage shareholder communication.
  • Compensation Committee Independence – The administration indicated it would propose legislation giving the SEC power to ensure that compensation committees are more independent, adhering to standards similar to those in place for audit committees as part of the Sarbanes-Oxley Act.  According to the Fact Sheet for this proposal, compensation committees also would be given the responsibility and the resources to hire their own independent compensation consultants and outside counsel.  The new requirements also will direct the SEC to establish standards for ensuring the independence of compensation consultants and outside counsel used by the compensation committee.  Issues raised by this proposal include whether existing directors serving on compensation committees would be grandfathered (so as to avoid the immediate need to replace directors under the new standards), and whether directors will need to be “experts” in compensation.

Treasury Department Guidance Applicable Only to TARP Recipients

On June 10, 2009, the Treasury Department also issued interim final rules that establish certain standards for executive compensation and corporate governance practices at firms receiving TARP assistance.  Click here for more background on the TARP rules as modified by the Recovery Act.

Most notably, the rule appoints a “Special Master” to approve or reject compensation plans at the seven firms receiving “Exceptional Assistance” under the Programs for Systemically Significant Failing Institutions, the Targeted Investment Program and the Automotive Industry Financing Program.  The Treasury Department indicated it would appoint Kenneth R. Feinberg as the Special Master.  Mr. Feinberg previously led the government’s September 11th Victim Compensation Fund.  In his role as Special Master, Mr. Feinberg would review any compensation for the 25 most highly compensated employees.  The Special Master will also be empowered to approve or reject the structure of compensation for the 100 most highly paid employees that are not subject to the bonus restrictions and any executive officers that are not among the 100 most highly paid employees.  The interim final rule establishes a “safe-harbor” under which the Special Master will automatically approve proposed compensation to employees of TARP recipients receiving exceptional assistance so long as the employee's total annual compensation is not more than $500,000.

The interim final rule also interprets important aspects of the Recovery Act’s executive compensation provisions applicable to all TARP recipients (i.e., not just those receiving exceptional assistance) including the following:

  • Limits on Bonus Payments – The interim final rule limits bonuses paid to senior executive officers (SEOs) to one-third of their total compensation.  SEOs are defined to include the "named executive officers" identified in the company's annual compensation disclosures and a specified number of the most highly compensated employees of TARP recipients depending upon the amount of financial assistance the company has received.  (For those institutions receiving over $500 million in assistance, the five SEOs and the 20 most highly compensated employees are covered.)  For purposes of applying the limits on bonus payments, the interim final rule defines "most highly compensated" employees by reference to total annual compensation (not including actuarial pension increases and above-market interest on deferred compensation amounts) as calculated under the federal proxy disclosure rules.  Commissions paid to employees are not subject to this bonus limitation to the extent payable under programs similar to commission programs already in place as of February 17, 2009, which is a significant concession that helps TARP recipients to continue to retain top investment traders.  TARP recipients  will need to expand the individuals with respect to whom the company tracks compensation, as an employee can be subject to this restriction without being an executive officer.
  • Prohibition on Payment of "Golden Parachutes" – The Recovery Act prohibits any golden parachute payment to a named executive officer or any of the next five most highly compensated employees.  While the Recovery Act limited the definition of golden parachutes to payments for an employee's departure for any reason, the interim final rule also clarifies that any payments made in connection with a change in control of the company are prohibited parachute payments.
  • Clawbacks – The Recovery Act mandates that bonuses paid to named executive officers and the next 20 most highly compensated employees be subject to a clawback if the payment was based on materially inaccurate performance criteria.  The interim final rule requires that the TARP recipient enforce its clawback rights upon a triggering event unless the TARP recipient can demonstrate that it would be unreasonable to do so (for example, if the expense of enforcing the clawback right exceeds the benefits of doing so).  Presumably, this determination would be made by the compensation committee or a subcommittee of independent directors.
  • Risk Analysis Required for Compensation of All Employees – As enacted, EESA required compensation plans for named executive officers to avoid incentives for unnecessary risk-taking.  The Recovery Act expanded that restriction to all employee compensation plans, and also to require that no employee compensation plan encourage the manipulation of earnings.  The interim final rule required that the compensation committee of the financial institution provide a narrative explanation of its analysis, allowing shareholders to evaluate directors' reasoning with respect to the risks presented by compensation plans.  It will be up to compensation committees to determine what type of compensation agreements avoid incentives for unnecessary risk taking.
  • Luxury Expenditure Policies – The interim final rule implements the Recovery Act's requirement that the board of directors of each TARP recipient establish a company-wide policy on luxury or excessive expenditures.  Specifically, the CEO and the CFO of each TARP recipient must certify that any expenditure requiring the approval of the board of directors or a senior executive officer (or any executive officer of a substantially similar level of responsibility) was properly approved, and requires that the policy mandate prompt internal reporting of any violations of the policy.
  • Prohibition on Tax Gross-Up The interim final rule prohibits the payment to SEOs and the 20 next most highly compensated employees of any tax "gross-up," or a payment to cover taxes due on compensation such as golden parachutes and perquisites.  There is no grandfathering exception for employment agreements entered into prior to EESA.
  • Additional Disclosure of Perks – TARP recipients must disclose the type and amount of any perquisite provided to any employee subject to the Recovery Act's bonus limitations with total value exceeding $25,000.  TARP recipients will also be required to provide a narrative description of, and justification for, the benefit.  Currently, perquisite disclosure is only required for named executive officers, and the cost of an individual perquisite only needs to be disclosed if it exceeds the greater of $25,000 or 10 percent of the total amount of the named executive officer’s perquisites.
  • Mandated Disclosure of Compensation Consultants – The interim final rule requires TARP recipients to disclose whether the company or its compensation committee engaged a compensation consultant.  It also requires TARP recipients to provide a narrative description of the services provided by the compensation consultant to the TARP recipient, including any non-compensation related services provided by the consultant or any of its affiliates, as well as a description of the use of any "benchmarking" procedures in the consultant's analysis.   This change may be considered by the SEC in developing guidance regarding the independence of compensation committees for all public companies. 

SEC Guidance Applicable to All Public Companies

On May 29, 2009, the SEC issued updated Compliance & Disclosure Interpretations (C&DIs).  The update included the following questions and answers regarding executive compensation:

  • What information needs to be shown in the Summary Compensation Table when an individual is a Named Executive Officer “NEO” in years one and three, but not year two of the years presented.  Information for all three years is required.
  • When to report information about gross-up payments made to an NEO when the gross up payment occurs in a year after the year in which the related perquisite or other compensation is provided.  Disclosure of the tax gross-up payment should be included in the Summary Compensation Table for the same year as the related perquisites or other compensation to which it relates.  Item 402 requires disclosure of “earned” compensation.
  • Whether to report the grant date value of an incentive award at threshold, target or maximum performance amounts in the Grants of Plan-Based Awards Table.  The maximum amount is to be shown.
  • How to report in the Grants of Plan-Based Awards Table the grant date value of a long term incentive award where part of the award is tied to a specific year’s performance.  If each annual performance target is set at the start of each respective single-year performance period, each of those dates is a separate grant date for purposes of measuring the grant date fair value of the respective tranche.  In this circumstance, only the grant date fair value for the first year's performance period would be measured and reported.
  • What to do if an outstanding award is amended or modified during the year.  The incremental fair value must be reported in the Grants of Plan-Based Awards Table in the year of modification.
  • How to report in the Outstanding Equity Awards at Fiscal Year-End Table any awards earned pursuant to a performance requirement but still subject to a subsequent service requirement.  The number of shares reported should be based on the actual number of shares earned at the end of the performance period, but because they are no longer subject to performance-based conditions, they should  be reported as subject to service-based vesting.
  • How to treat life insurance proceeds.  If an executive officer dies during the last completed fiscal year, the proceeds of a life insurance policy funded by the registrant and paid to the deceased executive officer's estate need not be taken into consideration in determining the compensation to be reported in the Summary Compensation Table (or in determining whether the executive is among the registrant's up to two former employees for whom disclosure would be required).
  • What to do if a“Rabbi Trust” has been established.  If a company established a rabbi trust in connection with an existing nonqualified deferred compensation plan, the rabbi trust only needs to be filed as an exhibit to the Form 10-K or Form 10-Q for the quarter in which the agreement is entered into if it materially modifies participants' rights under the previously filed nonqualified deferred compensation plan.
  • 8-K Disclosure for Newly Appointed Directors.  If a company appoints a new director and triggers the obligation to file a Form 8-K, the Form 8-K must describe the director's compensation arrangement even if it is the standard director arrangement.  In lieu of describing the standard arrangement, the company can cross reference the description of the arrangement from the company's most recent annual report on Form 10-K or proxy statement.
  • 8-Ks for Blackout Periods.  A Form 8-K filing is not required for every "blackout period" under ERISA; it is only for those blackout periods that also constitute a "blackout period" for purposes of Section 306(a) of the Sarbanes-Oxley Act of 2002 and Regulation BTR.

Finally, SEC Chairman Mary L. Schapiro recently testified about changes the SEC will consider for a broad package of corporate disclosure improvements, all designed to provide shareholders with important information about their company's key policies, procedures and practices, including compensation policies and incentive arrangements.  For example, the Commission will consider:

  • Proposals to enhance disclosure of director nominee experience, qualifications and skills, so that shareholders can make more informed voting decisions
  • Proposed disclosures to shareholders about why a board has chosen its particular leadership structure (whether that structure includes an independent chair or combines the positions of CEO and chair), so that shareholders can better evaluate board performance
  • Whether greater disclosure is needed about how a company—and the company's board in particular—manages risks, both generally and in the context of compensation
  • Whether greater disclosure is needed about a company's overall compensation approach, beyond decisions with respect only to the highest paid officers, as well as about compensation consultant conflicts of interests