- Additional Executive Comp. Restrictions for Recipients of TARP Funds
- March 17, 2009
- Law Firm: LeClairRyan - Richmond Office
On February 17, 2009, President Obama signed into law the American Recovery and Reinvestment Act of 2009 (“ARRA”), widely known as the Stimulus Package. The ARRA significantly expands the executive compensation restrictions already imposed upon recipients of Troubled Asset Relief Program (“TARP”) funds under the Emergency Economic Stabilization Act of 2008 (“EESA”). A number of the executive compensation guidelines announced by the U.S. Department of the Treasury on February 4, 2009 (the “Treasury Guidelines”), and several contained in the initial U.S. Senate version of the Stimulus Package are also incorporated into the ARRA. The following is a summary of all executive compensation restrictions applicable to TARP recipients.
One of the most controversial aspects of the TARP executive compensation limitations and governance provisions is their applicability to not only all future recipients of TARP funds, but also to those financial institutions that have already received such funds. These restrictions apply during the period the TARP recipient has an obligation outstanding that arises from TARP financial assistance. It is worth noting, however, that the executive compensation restrictions will no longer apply to an entity if Treasury holds only warrants to purchase common stock of the TARP recipient, i.e. the restrictions no longer apply once Treasury no longer owns preferred shares of the entity.
The following limitations apply to the five most highly paid senior executive officers of an entity, as determined by compensation reported on the TARP recipient’s proxy statement (SEOs). Depending on the amount of TARP funds received by an entity, these limitations may also apply to a broader group of employees. The restrictions are:
I. Exclusion of Incentives Encouraging Excessive Risk-Taking. Compensation must exclude incentives for executives to engage in excessive risk-taking that could potentially threaten the value of a financial institution.
II. Prohibition of Plans that Encourage Earnings Manipulation. Any compensation plan that would encourage manipulation of the reported earnings of a TARP recipient to enhance the compensation of any of its employees is expressly prohibited.
III. Clawback of Bonuses. Any bonus, retention award or incentive compensation based on earnings, revenues, gains or other criteria that are later found to be materially inaccurate must be paid back by the individual receiving such compensation. This provision is included in the ARRA and goes beyond previous Treasury guidelines by extending the clawback to include not only amounts paid to the five SEOs, but also any bonuses paid to the next twenty most highly compensated employees.
As a practical matter, this provision requires the clawback of bonuses and incentive payments only to the extent they are based on financial statements or performance metrics that are later proven to be materially inaccurate. For example, assume an SEO receives a $100,000 bonus based on achieving a target metric. If it is later determined that the target metric was not met, but a lower metric that would have resulted in a $60,000 bonus was met, only the additional $40,000 would be subject to clawback.
IV. No Golden Parachutes. “Golden parachute” payments, defined to include any payment to the five SEOs of an entity and the next five most highly compensated employees for departure from a company for any reason, are entirely banned. Payments for services performed or benefits accrued are excepted from the golden parachute ban. The ARRA expands the definition of “golden parachute” to extend to all severance and not just severance that would not be deductible for federal income tax purposes.
V. Ban on Bonuses/Incentive Compensation (Except for Restricted Stock). Certain executives of financial institutions receiving TARP funds are banned from receiving any bonus, retention or incentive compensation, other than long-term restricted stock which meets the following criteria:
(a) Does not fully vest during the period Treasury owns preferred shares of the TARP recipient;
(b) Has a value no greater than one-third of the total annual compensation of the employee receiving the stock; and
(c) Is subject to such other restrictions as the Secretary of the Treasury may determine are in the public interest.
The number of executives subject to the ban on bonuses and incentive compensation is a function of the amount of federal assistance received by the TARP recipient:
Level One: The Bonus/Incentive Prohibition applies to only the single most highly compensated employee of a financial institution that received less than $25 million in financial assistance.
Level Two: The Bonus/Incentive Prohibition applies to the five most highly compensated employees of a financial institution that received at least $25 million but less than $250 million in financial assistance.
Level Three: The Bonus/Incentive Prohibition applies to the senior executive officers and the 10 next most highly compensated employees of a financial institution that received at least $250 million but less than $500 million in financial assistance.
Level Four: The Bonus/Incentive Prohibition applies to the senior executive officers and the 20 next most highly compensated employees of a financial institution that received $500 million or more in financial assistance.
It is important to note that bonus payments required to be paid pursuant to a written employment contract executed on or before February 11, 2009 are not affected by the ban on bonuses and incentive compensation. The caveat is that the employment contracts authorizing such bonuses must be approved by Treasury.
Mandatory Board Compensation Committee
Each TARP recipient is required to form a Board Compensation Committee (“BCC”) which must be comprised entirely of independent directors. For TARP recipients receiving less than $25,000,000, the functions of the BCC may be performed by the board of directors as a whole.
The BCC must meet at least semiannually to discuss and evaluate employee compensation plans in light of any risks posed to the TARP recipient by such plans. The BCC must then certify that it has completed these reviews and that the committee has made reasonable efforts to ensure that SEO incentive compensation arrangements are appropriately designed to avoid unnecessary and excessive risk taking. This certification must be included in the “Compensation Committee Report” section of the annual proxy statement. The model language prescribed by Treasury for the certification is as follows:
“The compensation committee certifies that it has reviewed with senior risk officers the senior executive officer incentive compensation arrangements and has made reasonable efforts to ensure that such arrangements do not encourage the senior executive officers to take unnecessary and excessive risks that threaten the value of the financial institution.”
Tax Deduction Limitation
Compensation in excess of $500,000 to a TARP recipient’s executive officers will not be deductible under Section 162(m)(5) of the Internal Revenue Code. The $500,000 tax deduction limitation for SEO compensation applies to the executive officers identified in the company’s proxy statement for the year following the year in which the contractual limitation on the tax deduction applies.
Company-Wide Luxury Expenditure Policy
TARP recipients are required to implement a company-wide policy regarding excessive/luxury expenditures (as to be defined by Treasury) on:
(i) Events and entertainment;
(ii) Office and facility renovations;
(iii) Aviation and transportation services; and
(iv) Other activities/events that are not conducted in the normal course of business operations.
Non-Binding “Say on Pay”
Each TARP recipient must conduct an annual, non-binding shareholder vote on senior executive compensation. For a public company, this can be accomplished by a non-binding resolution voted as a separate shareholder vote to approve the compensation of executives as disclosed pursuant to the Securities & Exchange Commission (SEC) rules, including the compensation discussion and analysis, compensation tables, and any related materials.
Revised rules issued by Treasury on January 16, 2009 impose the following reporting and record-keeping requirements on financial institutions participating in TARP:
(i) Requirement that the principal executive officer (“PEO”) certify, within 120 days of the closing date of Treasury’s purchase, that the institution’s compensation committee has reviewed SEO incentive compensation arrangements with its senior risk officers to ensure that the arrangements do not encourage SEOs to take unnecessary or excessive risks that threaten the value of the institution;
(ii) Requirement that the PEO certify, within 135 days of the close of each fiscal year during any part of which it has participated in TARP, that the institution has complied with all of the TARP executive compensation requirements and limitations and to identify the institution’s SEOs;
(iii) Requirement that the institution preserve appropriate documentation and records to substantiate each required certification for at least six years after the date of certification; and
The making or providing of false statements in connection with a certification to Treasury constitutes a criminal offense.
Previously Paid Bonuses Subject to Treasury Review
The Secretary of the Treasury is empowered to review all bonuses and incentive compensation paid to SEOs and the next 20 most highly compensated employees of each TARP recipient before enactment of the ARRA, to determine whether any such payments were inconsistent with the purposes of the ARRA or were otherwise contrary to the public interest. If Treasury makes either finding, it is directed to negotiate with the employee receiving the compensation for reimbursement of all or a portion of the bonus.
Bailing Out of the Bailout
TARP recipients now have the option, after consultation with the appropriate federal banking agency, to repay any assistance previously provided under TARP, without regard to what source the funds come from. When the TARP funds are repaid, Treasury is directed to liquidate any warrants associated with the assistance at the current market price.
Nota Bene: Both the ARRA and the Treasury Guidelines contemplate that the Secretary of the Treasury will adopt standards that will implement many of the executive compensation provisions included therein. These standards will, presumably, provide considerable additional guidance regarding how these unprecedented restrictions would be applied.