Treasury Department Announces Executive Compensation Restrictions, Corporate Governance Standards for TARP Participants
On June 10, 2009, Treasury issued a new Interim Final Rule implementing the executive compensation and corporate governance standards of the Emergency Economic Stabilization Act of 2008 ("EESA"), as amended by the American Recovery and Reinvestment Act of 2009 ("ARRA"). The Interim Final Rule applies to all entities (public and private) that have received or will receive financial assistance under the Troubled Asset Relief Program ("TARP") as well as any entity within a TARP participant's parent-subsidiary controlled group (using a 50% ownership test).
The Interim Final Rule consolidates all executive compensation related provisions that are specifically directed at TARP participants into one rule and, along with the provisions of the ARRA, supersedes all prior executive compensation rules and guidance issued by Treasury under EESA, including the executive compensation guidelines announced by Treasury in February 2009. The Interim Final Rule became effective June 15, 2009. The following are highlights of certain requirements contained in the Interim Final Rule for TARP participants:
- Limits on Bonuses, Incentive Compensation and Retention Awards. The Interim Final Rule prohibits the payment of bonuses, incentive compensation and retention awards to senior executive officers and certain other highly compensated employees. The number of covered employees depends on the amount of financial assistance received by the TARP participant. Awards of long-term restricted stock or stock units are permitted so long as the award (i) does not fully vest before repayment of the TARP assistance and (ii) the total fair market value of the award on its grant date is not more than one third of the recipient's total compensation for that year. Certain commissions paid to employees are not subject to this bonus limitation to the extent payable under programs similar to commission programs already in place as of February 17, 2009. TARP participants are also permitted to pay bonuses required to be paid pursuant to written employment contracts and certain compensation plans in effect as of February 11, 2009.
- Required Annual Disclosure of Perquisites in Excess of $25,000. A TARP participant is required to disclose to Treasury any perquisite or other personal benefit provided to any employee subject to the bonus limitations where the total value of such perquisite exceeds $25,000, as well as a justification for providing the perquisite.
- Required Disclosure of Engagement of Compensation Consultant. A TARP participant must annually disclose to Treasury and its primary regulator whether it, its board, or its compensation committee has engaged a compensation consultant and any services (compensation or non-compensation related) the consultant or its affiliates have provided to the participant in the last three years.
- Prohibition Against Tax Gross-Ups. Payments of any tax gross-ups with respect to any compensation, other than payments under a tax equalization agreement, to a senior executive officer and the next 20 most highly compensated employees of a TARP participant are prohibited.
- Prohibition Against Compensation Plans That Encourage "Unnecessary and Excessive" Risks or Manipulate Earnings. Before the later of 90 days after closing an agreement with Treasury or September 14, 2009, most TARP participants must establish a compensation committee composed of independent members of the board of directors. The committee is required to meet at least every six months with senior risk officers to evaluate and review senior executive officer and employee compensation plans and to focus on the risks such plans pose to the TARP participant, such as encouraging unnecessary and excessive risks or the manipulation of earnings results. The compensation committee of the TARP participant must provide a narrative explanation of its analysis that a compensation plan does not encourage these risks, allowing shareholders to evaluate directors' reasoning with respect to the risks. It will be up to compensation committees to determine what type of compensation agreements avoid such risks. Annually, the compensation committee must certify that it has completed its review of the compensation plans and provide a narrative description of how it limited these undesirable plan features.
- Prohibition Against Severance Pay Generally. The Interim Final Rule prohibits severance and golden parachute payments to any senior executive officer or any of the next five most highly compensated employees. Prohibited payments include payments made for the departure of an employee for any reason (excluding death or disability), and any payment due to a change in control of the TARP participant, except for payments for services performed or benefits accrued. The acceleration of vesting due to a departure or a change in control event is also considered a prohibited payment.
- "Clawback" for Any Bonus Based on Materially Inaccurate Performance Criteria. TARP participants must create a provision for recovery (clawback) of any bonus payment paid to any employee subject to the bonus limitation where the bonus was based on materially inaccurate financial statements or other materially inaccurate performance criteria.
- Reduced Executive Compensation Tax Deduction Limit. TARP participants continue to be required to limit their deductions of executive compensation for each of their five senior executive officers, pursuant to Internal Revenue Code Section 162(m)(5), to $500,000.
- Required Certification of Approval of "Excessive or Luxury" Expenditures. TARP participants must establish a written policy addressing excessive or luxury expenditures (e.g. entertainment, office renovations, aviation and other expenditures considered unreasonable in the course of the participant's normal business operations), and this policy must be posted on the participant's website and provided to Treasury and the participant's primary regulator, all before September 14, 2009.
- CEO and CFO Certifications. CEOs and CFOs of TARP participants are required to certify compliance with the requirements and standards of the Interim Final Rule. These certifications will be submitted to Treasury and filed with the TARP participant's Form 10-K or, for a private company, with its primary regulatory agency.
- Say-On-Pay. The Interim Final Rule reiterates the requirement that TARP participants permit a separate, non-binding, shareholder vote to approve the compensation of executives as required to be disclosed pursuant to the rules, regulations, and guidance promulgated by the SEC.
- Creation of Office of Special Master. The Office of Special Master for TARP Executive Compensation will have the authority, among other things, to approve or reject any compensation plans of those firms receiving "Exceptional Assistance" under the Programs for Systemically Significantly Failing Institutions, Targeted Investment Program and The Automotive Industry Financing Program. Compensation arrangements that are excessive, inappropriate or designed to encourage unsound risk-taking may be disapproved by the special master. The special master also will be empowered to oversee the review of bonuses, retention awards and other compensation paid before February 17, 2009, and to negotiate appropriate reimbursements to the government. Kenneth Feinberg, Special Master of the September 11th Victim Compensation Fund, will serve as the Special Master for TARP Executive Compensation.
TARP participants should be mindful that many provisions of the Interim Final Rule apply differently depending on whether the participant is public or private, the level of TARP financial assistance received by the participant and the varying levels of compensation of the participant's employees. Each TARP participant should establish adequate controls to identify employees covered by the Interim Final Rule and to comply with the particular provisions that apply to it.
Frost Brown Todd has in depth knowledge of banking and securities law and regulation and expansive experience representing public and private companies in corporate and securities transactions. Our law firm has assisted a number of financial institutions and public companies on issues related to the Treasury's Troubled Asset Relief Program, including the application process, closing of approved purchases and compliance with executive compensation and corporate governance rules. We will continue to monitor developments related to this advisory and any upcoming guidance.
For more information or assistance, please contact your regular Frost Brown Todd LLC attorney or one of the members of our Financial Institutions, Public Companies and Securities, or Executive Compensation practice groups.