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02.17.2009 | Legal Update

The American Recovery and Reinvestment Act of 2009 (ARRA), approved by Congress on February 13 and expected to be signed by the President today, imposes additional executive compensation and governance requirements on financial institutions that participate in the Capital Purchase Program (CPP) or other programs under the Troubled Assets Relief Program (TARP).  The new rules will apply to institutions that have already received TARP assistance, as well as those that receive TARP assistance in the future.

1.  Regulations Required to be Issued by Treasury

The Secretary of the Treasury (Treasury) is required to issue regulations imposing additional “appropriate” executive compensation and governance standards on TARP recipients.  The new rules are to be applicable only during the period in which a TARP recipient’s obligation arising from financial assistance provided under the TARP remains outstanding.  In a change of policy, the new law generally allows TARP assistance to be repaid immediately.  See Section 7 below.  Treasury’s regulations are required to include, among other requirements:

• A ban on a TARP recipient paying or accruing any bonus, retention award or incentive compensation to a specified number of employees.  For financial institutions receiving less than $25 million under the TARP, the prohibition will apply only to the single most highly compensated employee.  For financial institutions receiving at least $25 million but less than $250 million under the TARP, the prohibition will apply to at least the five most highly compensated employees, and more if Treasury so determines.  For institutions receiving TARP assistance of $250 million or more, the rules will apply to significantly more employees, depending on the amount of assistance provided.  The prohibition will not apply to a long-term restricted stock award as long as the restricted stock does not fully vest during the period in which any TARP obligation (other than warrants for the purchase of common stock) remains outstanding, has a value that is not greater than 1/3 of the total amount of the employee’s annual compensation, and complies with any other terms and conditions imposed by Treasury.  The prohibition also will not apply to any bonus payment required to be paid under a written employment contract executed on or before February 11, 2009, as determined by Treasury.
• A ban on any golden parachute payment to any TARP recipient’s senior executive officers or any of its next five most highly compensated employees.  The term “golden parachute payment” is defined much more broadly than under Section 18(k) of the Federal Deposit Insurance Act.  For purposes of the new restrictions, the term means “any payment to a senior executive officer for departure from a company for any reason, except for payments for services performed or benefits accrued.”
• A ban on incentives for senior executive officers of a TARP recipient to take “unnecessary and excessive risks” that threaten the institution’s value while TARP assistance remains outstanding.
• A requirement that a TARP recipient recover any bonus, retention award or incentive compensation paid to any of its senior executive officers and any of its next 20 most highly compensated employees that was based on statements of earnings, revenues, gains or other criteria that are later found to be materially inaccurate.
• A ban on any compensation plan that would encourage manipulation of a TARP recipient’s reported earnings in order to enhance the compensation of any of its employees.
• A requirement that each TARP recipient establish a Board Compensation Committee for the purpose of reviewing employee compensation plans.  The committee 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 by such plans.  If the TARP recipient is not publicly traded and received $25,000,000 or less in TARP assistance, the duties of the Board Compensation Committee are required to be carried out by the full board of directors.  Otherwise, the Board Compensation Committee is required to be a board committee comprised entirely of independent directors.

2.  Limitation of Luxury Expenditures

The board of directors of a TARP recipient must adopt a company-wide policy covering excessive or luxury expenditures, as identified by Treasury, which may include excessive expenditures on entertainment or events, office and facility renovations, aviation or other transportation services, or any other activities or events that are not reasonable expenditures for staff development, performance incentives or other similar measures conducted in the ordinary course of business.

3.  Say-on-Pay

A TARP recipient must permit a separate non-binding shareholder vote to approve the compensation of the institution’s executives.  The disclosures provided to shareholders in the proxy statement must be in accordance with SEC compensation disclosure rules, and must include compensation discussion and analysis, compensation tables and related materials.  The SEC may adopt new regulations implementing the say-on-pay provision.  It remains to be seen whether the SEC will apply the say-on-pay provisions even to those TARP recipients that are not required to file proxy statements with the SEC.

4.  Recovery of Prior Payments to Executives

Treasury is required to review bonuses, retention awards, and other compensation paid to senior executive officers and the next 20 most highly-compensated employees of a TARP recipient before the enactment of ARRA.  If Treasury determines that any such payment was inconsistent with the purposes of the new executive compensation requirements, or was otherwise contrary to the public interest, Treasury is required to “seek to negotiate” with the TARP recipient and the employee for “appropriate reimbursements” to Treasury.

5.  Limits on Deductibility of Compensation

The law makes a TARP recipient subject to certain restrictions in Section 162(m)(5) of the Internal Revenue Code which generally limits the deduction for compensation paid to certain senior executives to $500,000.

6.  Certification of Compliance

The chief executive officer and chief financial officer of a TARP recipient are required to provide a written certification of compliance with the executive compensation and governance requirements on behalf of the institution.  In the case of a TARP recipient that is publicly traded, the certification must be filed with the SEC with the institution’s annual filings.  In the case of other TARP recipients, the certification must be filed with Treasury.

7.  Repayment of TARP Assistance Permitted

The new law requires Treasury to permit TARP recipients to repay any assistance provided under TARP without a waiting period and without regard to whether the institution has replaced the funds from any other source, subject to consultation by Treasury with the institution’s primary federal regulator.  When any assistance is repaid, Treasury must liquidate warrants associated with the assistance at the current market price.  As indicated above, the new executive compensation and governance rules will be applicable only during the period in which a TARP recipient’s obligation arising from financial assistance provided under the TARP remains outstanding.  This would not include any period in which Treasury only holds warrants to purchase common stock of the TARP recipient.

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