Economic Stimulus Package Imposes New Executive Pay Restrictions On TARP Recipients

Under the American Recovery and Reinvestment Act of 2009—commonly known as the economic stimulus package—recipients of relief under the Troubled Assets Relief Program (TARP) will face new restrictions on their executive pay programs and must comply with new corporate governance standards.

The Act modifies Section 111 of the Emergency Economic Stabilization Act of 2008 (EESA) under which TARP was created. Modified provisions of Section 111 apply not just prospectively, but to all TARP recipients, i.e., any entity that has received or will receive financial assistance under the financial assistance provided by TARP.

While the full impact of these changes is not yet certain—due to language used in certain provisions or because the law calls for additional regulatory action—restrictions are clearly more stringent than those previously governing the U.S. Department of Treasury's Capital Purchase Program and others announced by the Treasury in early February.

Executive Compensation and Corporate Governance Standards

Section 111 of EESA requires each TARP recipient to meet "appropriate standards for executive compensation and corporate governance." The new legislation continues to impose that requirement, but now specifies standards that, in general, are significantly broader and more restrictive than those originally described. These standards include:

Change in Restriction Period for Compensation Excluding Incentives for Risk

Limits were previously in place for compensation that excludes incentives for senior executive officers to take unnecessary and excessive risks that threaten the value of the recipient during the period in which any obligation arising from financial assistance is outstanding.

The principal change brought about by the Act is that the relevant period when such restriction (and each of the other TARP executive compensation standards) applies—the period in which any obligation arising from financial assistance is outstanding—excludes any period in which the Treasury holds only warrants to purchase common stock of the TARP recipient. Formerly, the relevant period was the period during which the Treasury holds an equity or debt position in the financial institution, which would have included the period after which any debt held by the Treasury had been paid but while warrants remained outstanding.

As before, "senior executive officers" refers to any of the five most highly paid executives whose compensation is required to be disclosed under the Securities Exchange Act of 1934 and regulations issued under the Exchange Act and their non-public-company counterparts.

Extension of Compensation Clawback to 20 Most Highly Paid Executives

The Act allows for recovery by the TARP recipient of any bonus, retention award or incentive compensation paid to a senior executive officer or any of the next 20 most highly compensated employees of the TARP recipient based on statements of earnings, revenues, gains or other criteria that are later found to be materially inaccurate. Section 111 of EESA as originally adopted subjected only senior executive officers to the recovery provisions. The Act extends this clawback further down into the organization to the top 20 next most highly paid employees.

Expanded Definition of 'Parachute Payment'

TARP recipients are now prohibited from making any golden parachute payment to a senior executive officer or any of the next five most highly compensated employees of the TARP recipient during the period in which any obligation arising from financial assistance provided under TARP remains outstanding.

A similar provision was included in Section 111 of EESA as originally adopted but applied only to senior executive officers. The amended version of Section 111 now clarifies that a "golden parachute payment" is any payment to a senior executive officer (and, presumably, the next five most highly compensated employees, although the definition omits that reference) for departure for any reason, except for payments for services performed or benefits accrued.

This definition of "parachute payment" is far more sweeping than the definition of parachute payment that previously applied. TARP recipients were prohibited severance payments to a senior executive officer only if the amount of such payments equaled or exceeded three times his or her base pay—and those payments were made upon an involuntary termination or events of bankruptcy. Unlike the bonus limitations described below, there is no general exception for existing contractual arrangements.

Prohibition on Paying or Accruing Bonuses, Awards and Compensation

TARP recipients are now prohibited from paying or accruing any bonus, retention award or incentive compensation during the period in which any obligation arising from financial assistance provided under TARP remains outstanding, except for the payment of long-term restricted stock. What constitutes "long-term restricted stock" is not specified, so it is not clear if stock options or restricted stock units could qualify as acceptable incentive compensation.

The new restrictions affect vesting terms and the amount of long-term restricted stock that may be issued.

• Vesting. The restricted stock is not allowed to fully vest during the period in which any obligation arising from financial assistance provided to the TARP recipient remains outstanding.
• Amount. The restricted stock cannot have a value more than one-third of the total amount of annual compensation of the employee receiving the stock. It is not clear from the provision how the value of the restricted stock or the annual compensation of the employee is determined.

Employees to whom these restrictions apply vary depending upon the amount of TARP assistance that has been furnished to the financial institution.

• Less than $25 million. The prohibition applies to only the most highly compensated employee.
• At least $25 million but less than $250 million. The prohibition applies to at least the five most highly compensated employees or such higher number as Treasury may establish.
• At least $250 million but less than $500 million. The prohibition applies to the senior executive officers and at least the 10 next most highly compensated employees or such higher number as Treasury may establish.
• $500 million or more. The prohibition applies to the senior executive officers and at least the 20 next most highly compensated employees or such higher number as Treasury may establish.

Notably, this provision refers to the amount of TARP assistance provided to the recipient, rather than the amount of TARP assistance outstanding. Therefore, it is unclear whether a TARP recipient that has repaid a portion of its TARP assistance to the Treasury would continue be bound by the prohibition corresponding to the greatest amount of assistance it received under TARP.

The prohibition on bonus payments does not apply to any bonus payment required to be paid pursuant to a written employment agreement executed on or before February 11, 2009. It is unclear whether this carve-out extends to incentive payments, which are otherwise separately identified.

Prohibition on Compensation Plans That Would Encourage Manipulation of Earnings

A prohibition is imposed on any compensation plan that would encourage manipulation of the reported earnings of the TARP recipient to enhance the compensation of any of its employees. The vagueness of this standard, which is newly introduced by the Act, makes its impact difficult to assess. One point worth noting is the broad reference in the prohibition to "any compensation plan," which suggests that forms of compensation other than incentive-based arrangements may be deemed to encourage manipulation of reported earnings.

Establishment of Board Compensation Committee

TARP recipients are now required to establishment a Board Compensation Committee for the purpose of reviewing employee compensation plans. The committee must be composed entirely of independent directors and must meet at least semiannually to discuss and evaluate employee compensation plans in light of an assessment of any risk posed to the TARP recipient from such plans. For any TARP recipient whose common or preferred stock is not registered under the Exchange Act and has received no more than $25 million in TARP assistance, its board of directors is permitted to carry out the duties of such a committee.

Additional Obligations Under American Recovery and Reinvestment Act

The Act imposes a number of additional obligations on TARP recipients:

• Certificate of compliance. The chief executive officer and chief financial officer are required to certify in writing their compliance with the standards of executive compensation and corporate governance. Treasury regulations had imposed a similar certification requirement as well, but on the chief executive officer only. Public companies must provide this certification to the Securities and Exchange Commission with their annual filings required under the securities laws, while private companies are required to provide it to the Treasury.
• Limitation on luxury expenditures. TARP recipient boards of directors are now required to have in place a company-wide policy regarding "excessive or luxury expenditures." The Treasury is to identify such excessive or luxury expenditures, which the Act indicates may include entertainment or events; office and facility renovations; aviation or other transportation services; or other activities or events that are not reasonable expenditures for staff development, reasonable performance incentives, or other similar measures conducted in the normal course of the business operations of the TARP recipient. Treasury guidance, when forthcoming, may help to shed light on what is and is not permissible under such a policy.
• Shareholder "say on pay." TARP recipients must permit a separate non-binding shareholder vote to approve the compensation of executives in any proxy or consent or authorization of an annual or other meeting of its shareholders during which any TARP obligation remains outstanding. The language of the Act says "shall permit," which could be construed to mean nothing more than "not oppose." However, the remarks of Connecticut Senator Christopher Dodd, who proposed the amendment to the Act that included this shareholder vote, suggest the provision was intended to make such a vote automatic, with the purpose of eliminating the need for a shareholder proposal. It is unclear whether TARP recipients are required to comply with the shareholder vote requirement immediately, or whether they may wait until the SEC issues final regulations regarding such requirement—which, under the Act, it has been given one year from enactment to do.
• Treasury review of past compensation. The Act directs the Treasury to review bonuses, retention awards and other compensation that has already been paid to the senior executive officers and the next 20 most highly compensated employees of TARP recipients. The Treasury is to determine whether any of those payments were inconsistent with the purposes of Section 111 of EESA or TARP or contrary to the public interest. If the Treasury determines that such payments were made, it is to negotiate with the TARP recipient and the employee for "appropriate reimbursement" to the federal government of that compensation. There is no indication in the Act of how far back the Treasury must or is allowed to go in its investigation of past payments of such compensation.

Repayment Now an Easier Way Out

For TARP recipients dismayed by the limitations and obligations created under the Act, the new law offers an easier exit from TARP. The Treasury, in consultation with a recipient's primary federal regulator, may now permit a TARP recipient to repay any assistance previously received without regard to any waiting periods and without regard to whether the capital is replaced by other Tier 1 capital. When the TARP assistance is repaid, the Treasury is directed to liquidate warrants at "the current market price."

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