On February 4, 2009, the U.S. Treasury Department, in accordance with a strong statement by President Obama, issued a new set of guidelines (the "Guidelines") on executive pay for financial institutions receiving government assistance under the Troubled Assets Relief Program ("TARP"). TARP is the designation for the overall program under which the U.S. Treasury Department originally was to acquire billions of dollars in troubled assets currently authorized by the Emergency Economic Stabilization Act of 2008, which was passed on October 3, 2008 ("EESA"). The U.S Treasury Department abandoned its original plan to buy troubled assets from financial institutions and used TARP money to make direct equity investments in financial institutions. We expect that there will be additional developments regarding the executive compensation rules as Congress continues to debate the terms of an additional economic recovery package.
The Guidelines divide financial institutions that receive government funds under TARP into two categories: (i) banks participating in any "generally available capital access programs"; and (ii) banks needing "exceptional assistance." The purpose of generally available programs, which have the same terms for all recipients, is to ensure that the financial system as a whole can provide the credit necessary for economic recovery. An example of a generally available capital access program is the Capital Purchase Program ("CPP"). In contrast, exceptional financial recovery assistance programs are individually negotiated with the recipient in order to provide additional funds than would be allowed under the widely available standard program. Examples of institutions that have received this exceptional assistance include AIG, Bank of America and Citi.
TARP imposed important restrictions on compensation to certain senior executives of financial institutions while the institution participates in TARP programs. The Guidelines further restrict executive compensation that can be paid by institutions that receive exceptional financial recovery assistance and proposes additional restrictions on those receiving generally available assistance. With the exception of the CEO and compensation committee certification of compliance requirements described below, the new Guidelines do not apply to institutions that already have received assistance or to financial assistance programs already in place.
Executive Compensation Restrictions For Companies Receiving Exceptional Financial Recovery Assistance
- Limit Senior Executives to $500,000 Total Annual Compensation Plus Restricted Stock. Under the EESA, programs offering exceptional assistance to financial institutions merely prevented a company from taking a tax deduction for senior executive officers' ("SEO") compensation above $500,000 under Internal Revenue Code 162(m). For this purpose, an SEO generally is a named executive officer as determined annually under the proxy statement rules. The Guidelines limit the total compensation that can be paid to $500,000 for senior executives, except for restricted stock awards (or similar long-term incentive). These restricted stock awards must be structured so that the executive may only "cash them in" after the government has been repaid, including contractual dividend payments (or after a specified period if certain factors have been satisfied).1
- Executive Compensation Disclosure and Say on Pay Shareholder Resolution. The Guidelines require that the senior executive compensation package structure and the rationale for how it is tied to sound risk management must be submitted for a nonbinding shareholder resolution. There were no say on pay requirements under the existing program.
- Bonus Clawback Provisions. A company receiving exceptional assistance must have in place provisions to claw back bonuses and incentive compensation from any of the top twenty-five 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. Under the EESA, such a clawback provision was only required for the top five senior executives.
- Golden Parachute Restrictions. While the EESA prohibited the top five senior executives from receiving any golden parachute upon severance from employment, the Guidelines expand the ban to include the top ten senior executives. Additionally, the next twenty-five senior executives will be prohibited from receiving any golden parachute payment greater than one year's compensation.
- Approval of Luxury Expenditures. The Guidelines require that the boards of directors of companies receiving exceptional assistance adopt policies related to aviation services, office and facilities renovation, entertainment and holiday parties, and conferences and events. The text of these policies is to be posted on the companies' websites. Chief executive officers are required to certify expenditures that would be viewed as excessive or luxury.
Executive Compensation Restrictions For Companies Participating In Generally Available Capital Access Programs
The Treasury intends to issue proposed guidance, subject to public comment, relating to the executive compensation packages relating to future generally available capital access programs.
- Limit Senior Executives to $500,000 in Total Annual Compensation Plus Restricted Stock. Companies that participate in generally available capital access programs are subject to the $500,000 plus restricted stock limitation on the executive compensation of SEOs unless they disclose their compensation packages and, if requested, submit the compensation packages for a non-binding say on pay shareholder resolution. Previously, companies participating in the program were only required to review and certify that the top five senior executives' compensation arrangements did not encourage excessive and unnecessary risk-taking.
- Clawback Provision Requirement. The same clawback provisions that apply to companies receiving exceptional assistance will apply to those in generally available capital access programs. Thus, in addition to the clawback provisions already applicable to the top five senior executives under the CPP, clawback provisions must be in place for the next twenty senior executives if they are found to have knowingly engaged in providing inaccurate information relating to the financial statements or performance metrics used to calculate their own incentive pay.
- Golden Parachute Restrictions. Upon a severance from employment, the top five senior executives will not be allowed a golden parachute payment greater than one year's compensation. Under the CPP, executives were permitted a golden parachute payment up to three years' compensation.
- Approval of Luxury Expenditures. Companies that participate in generally available capital access programs will be required to comply with the same luxury expenditure procedures as companies receiving exceptional assistance.
Certification Of Compliance
The chief executive officers of all companies that have received, or do receive, any form of government assistance must provide certification that their companies have strictly complied with statutory, Treasury, and contractual executive compensation restrictions. Chief executive officers must re-certify compliance with these restrictions on an annual basis. The compensation committees of all companies receiving government aid must provide an explanation of how their senior executive compensation arrangements do not encourage excessive and unnecessary risk-taking.
Long-Term Reform
While announcing the Guidelines, the U.S. Treasury Department has stated its intention to broadly examine the compensation strategies of financial institutions beyond that of the top senior executives and to develop a model of compensation policies for the future in order to create long-term executive pay reform. Proposals currently under consideration include:
(i) requiring all compensation committees of public financial institutions to review and disclose strategies for aligning compensation with sound risk management; (ii) requiring compensation packages to include incentives that encourage long-term prospective (such as requiring top executives to hold stock for several years after it is awarded before it can be "cashed out"); and (iii) requiring shareholder non-binding resolutions on executive compensation.
Current Discussion In Congress
More developments are expected soon since Congress is currently debating an additional economic recovery package that likely will address executive compensation issues. While the proposed legislation is generally consistent with the Guidelines discussed above, there are key differences that could make it into the final bill.
For more analysis on how TARP restricts executive compensation, please see our recent Client Alert available on our website at http://www.proskauer.com/news_publications/client_alerts/content/2008_10_13_b.
Footnote
1. The Guidelines do not provide an exhaustive list of factors (other than complete repayment) that will be used to determine when restricted stock can be "cashed in," but they do explain that the factors will include the degree a company has satisfied repayment obligations, protected taxpayer interests, or met lending and stability standards.
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