Alert February 17, 2009

Stimulus Act Modifies Executive Compensation Restrictions of Financial Institutions Participating in the TARP

The American Recovery and Reinvestment Act of 2009 (the “Stimulus Act”) modifies and expands upon the executive compensation standards that were originally issued under the Troubled Assets Relief Program (the “TARP”) and incorporates certain aspects of the standards announced by the Treasury earlier this month.  The Stimulus Act amends Section 111 of the Emergency Economic Stabilization Act (the “EESA”), the source of the TARP standards, thus applying retroactively to all institutions that already participate in the TARP (e.g., financial institutions that received funds under the Capital Purchase Program).  The restrictions of the EESA also apply to sponsors, including non-depository institutions, of asset-backed securities which are pledged as collateral for the Term Asset-Backed Securities Loan Facility.  The Stimulus Act now requires that TARP recipients adhere to the following:

Executive Compensation and Corporate Governance Standards.  The new standards apply during the period in which there is any outstanding obligation to the federal government arising from financial assistance provided under the TARP (other than any period during which the federal government holds only warrants to purchase common stock of the TARP recipient).  The new standards generally apply to “senior executive officers,” which are the top five most highly-compensated executives of a public company or the non-public company counterparts, except as otherwise specified.  The new standards include:

Compensation Restrictions.

  • A TARP recipient must limit compensation that excludes incentives for the senior executive officers to take unnecessary and excessive risks that threaten the value of the institution. 
  • A TARP recipient must put in place claw-back provisions to recover any bonus, retention award or incentive compensation paid to the senior executive officers and any of the next 20 most highly-compensated employees based on statements of earnings, revenues, gains or other criteria that are later found to be materially inaccurate.
  • The senior executive officers and the next five most highly-compensated employees of each TARP recipient are prohibited from receiving any “golden parachute payment” upon severance from employment.  For this purpose, the term “golden parachute payment” is now defined to mean any payment on account of a termination of employment, except for payments for services performed or benefits accrued.  This means that no severance payments are permitted at all.
  • A TARP recipient may not have compensation plans that encourage manipulation of the reported earnings of the TARP recipient in order to enhance the compensation of any of its employees.
  • A TARP recipient is prohibited from paying or accruing any bonus, retention award or incentive compensation, other than the payment of restricted stock that (i) does not fully vest during the period in which there is any outstanding obligation arising from financial assistance provided under the TARP, (ii) has a value no greater than one-third of the employee’s annual compensation and (iii) is subject to any other terms and conditions the Secretary of the Treasury determines.  This prohibition generally does not apply to any bonus payments required to be paid pursuant to a written employment contract executed on or before February 11, 2009.  Moreover, this prohibition applies only to the following employees of TARP recipients:
  1. The most highly-compensated employee of a TARP recipient receiving less than $25 million under the TARP.
  2. At least the top five most highly-compensated employees (or such higher number as the Secretary of the Treasury determines to be in the public interest) of a TARP recipient receiving at least $25 million but less than $250 million under the TARP.
  3. The senior executive officers and at least the ten next most highly-compensated employees (or such higher number as the Secretary of the Treasury determines to be in the public interest) of a TARP recipient receiving at least $250 million and but less than $500 million under the TARP.
  4. The senior executive officers and at least the 20 next most highly-compensated employees (or such higher number as the Secretary of the Treasury determines to be in the public interest) of a TARP recipient receiving $500 million or more under the TARP.
  • Under the Stimulus Act, TARP recipients continue to be subject to Section 162(m)(5) of the Internal Revenue Code, which generally limits the deductibility of compensation paid to the senior executive officers to $500,000 per year.

Compliance Certification.  The chief executive officer and chief financial officer of each TARP recipient must certify that such institution has strictly complied with all executive compensation restrictions.  Public companies must file this certification with the Securities and Exchange Commission (the “SEC”), together with its annual filings, and private companies must file this certification with the Secretary of the Treasury.

Compensation Committee.  Each TARP recipient must establish a compensation committee comprised solely of independent directors.  The compensation committee must meet at least semiannually to discuss and evaluate compensation plans and assess any risk posed to the TARP recipient from such plans.  In the case of privately-held TARP recipients receiving $25 million or less in TARP assistance, such duties of the compensation committee may be undertaken by the board of directors.

Policy on Luxury Expenditures.  The board of directors of any TARP recipient must adopt a company-wide policy regarding excessive or luxury expenditures, as determined by the Secretary of the Treasury, which may include those related to entertainment or events, office and facility renovations, aviation or other transportation services, or other activities or events that are not reasonable expenditures conducted in the normal course of the business operations. 

Shareholder Advisory Vote on Executive Pay.  During the period in which there is any outstanding obligation arising from financial assistance provided under the TARP, shareholders of a TARP recipient are entitled to approve the compensation of executives, as disclosed in the TARP recipient’s Compensation Discussion and Analysis and related compensation tables in the proxy statement.  However, the shareholder resolution is non-binding and may not overrule the board of director’s decision or create any fiduciary duty by the board.  In addition, the shareholder resolution does not restrict the ability of shareholders to make proposals for inclusion in the proxy related to executive compensation.  The SEC is required to implement rules regarding this requirement within one year of the date of enactment.

Retroactive Review.  The Stimulus Act provides that, in the case of a TARP recipient receiving assistance under the TARP prior to the enactment of the Stimulus Act, the Secretary of the Treasury is directed by Congress to review bonuses, retention awards, and other compensation of the senior executive officers and the next 20 most highly-compensated employees, in order to evaluate whether any such payments were “inconsistent with the purposes” of the EESA or the TARP or were “otherwise contrary to the public interest.”  In the event it is determined any of the payments should not have been made, the Secretary of the Treasury is directed by Congress to negotiate with the TARP recipient and the subject employee for reimbursement to the government of the compensation or bonus.

TARP Recipients May Withdraw Without Impediment

Many of the executive compensation restrictions discussed above are retroactive, which may cause TARP recipients to reconsider their participation in the TARP.  The Stimulus Act allows the Secretary of the Treasury, in consultation with the appropriate Federal banking agency, to repay any assistance provided under the TARP without regard to whether the TARP recipient has replaced such funds from any other source or to any waiting period.  This modifies the requirement in the Capital Purchase Program that for the three years following an investment, preferred shares may only be redeemed with a qualified equity offering of Tier 1 qualifying perpetual preferred stock or common stock which resulted in aggregate gross proceeds to the TARP recipient of at least 25% of the issue price of the senior preferred shares being redeemed.  The Stimulus Act further provides that when a TARP recipient repays the assistance it received under the TARP, the Treasury will liquidate any warrants associated with such assistance at their current market price.

Treasury Announces New Restrictions on Executive Compensation

Prior to the enactment of the Stimulus Act, the Treasury issued guidelines on February 4, 2009, outlining new restrictions on executive compensation for certain institutions receiving financial assistance from the federal government.  Although the Stimulus Act enacted several provisions that were similar to the guidelines issued by the Treasury, there were a few notable differences and exclusions: 

  • The Stimulus Act applies to all TARP recipients retroactively, while the Treasury’s guidelines largely apply to TARP recipients on a going-forward basis. 
  • The Treasury’s guidelines proposed a limitation on annual compensation payable to senior executives.  Such executives would be prohibited from receiving total annual compensation in excess of $500,000 with any excess to be paid in the form of long-term restricted stock with terms and conditions similar to those contained in the Stimulus Act.  However, this compensation limit may be waived for most TARP recipients (other than those receiving exceptional assistance) by submitting compensation to a “say on pay” shareholder resolution.
The Treasury’s guidelines also proposed steps to undertake long-term executive regulatory reform regarding executive compensation, including (i) requiring compensation committees of all public companies to disclose the ways in which compensation arrangements encourage sound risk management and long-term value and growth for their companies and their shareholders, (ii) requiring all companies’ shareholders to pass non-binding shareholder resolutions approving the compensation structure, and (iii) having the Secretary of the Treasury host a conference on executive compensation arrangements.