Tuesday, February 17th, 2009

On February 17, 2009, the President signed into law the American Recovery and Reinvestment Act of 2009 (the “Stimulus Act”). The Stimulus Act includes limits on executive compensation that apply retroactively to prior recipients of aid under the Troubled Asset Relief Program (“TARP”) as well as to future participants in TARP. Below is a summary of some of the most significant executive compensation provisions of the Stimulus Act.

General Executive Compensation Limitations and Requirements

During the period in which any obligation arising from financial assistance provided under TARP remains outstanding (other than the period during which the Federal government only holds warrants to purchase common stock of the TARP recipient), TARP recipients are subject to the following executive compensation limitations and to further terms and conditions to be adopted by Treasury within the next year:

+Bonus Restrictions. Any company receiving TARP funds is barred from paying “top earners” bonuses equal to more than 1/3 of their total annual compensation. The number of top earners included in this restriction is determined based on the amount of TARP money the company has received, with companies receiving the smallest amount of TARP dollars having the fewest number of employees subject to the restrictions (see chart below).

  • The term “compensation” is not defined in the Stimulus Act – there is an open question of whether it means just base salary or includes bonuses, benefits and other perks.
  • The compensation limits have a carve out for employees with employment contracts that include bonuses and were entered into before February 11, 2009, but only “as such valid employment contracts are determined by the [Treasury] Secretary.”
  • Only Vested Restricted Stock Bonuses Permitted. Permitted bonuses for top earners may only be paid in restricted stock that does not vest while the company has outstanding TARP obligations to Treasury. In addition, these permitted bonuses are subject to other terms and conditions that Treasury may determine are in the public interest.

+**Top Earning Employee(s) Subject to the Bonus Restrictions:

Amount of TARP Received

-Less than $25 million -$25 million < $250 million -$250 million < $500 million -500 million and more

Employees Subject to Compensation Restrictions

-The most highly-compensated employee (one person) -The 5 most highly-compensated employees -Senior executive officers and at least 10 of next most highly compensated employees (up to 15 people -Senior executive officers and at least 20 of next most highly compensated employees (up to 25 people)

+No Incentives that Encourage Unnecessary and Excessive Risks. Compensation plans must not include incentives for the top 5 senior executive officers to take unnecessary and excessive risks that threaten the value of the company.

+Prohibition on Compensation Plans that Would Encourage Manipulation of Earnings. Compensation plans may not encourage manipulation of the company’s reported earnings to enhance the compensation of any of its employees.

  • Expanded Clawback. Compensation plans must provide for the recovery of any bonus, retention award or incentive compensation paid to the top 5 senior executive officers and the 20 next most highly-compensated employees (maximum of 25 people) that were based on financial statements or other criteria that are later found to be materially inaccurate.

+No Golden Parachutes. No golden parachute payments may be made to the top 5 senior executive officers. The term “golden parachute” is broadly defined to include “any payment…for departure from a company for any reason, except for payments for services performed or benefits accrued.”

*Other Corporate Governance Provisions and Requirements

  • Independent Board Compensation Committee. Companies receiving TARP money must establish a Board of Directors Compensation Committee composed entirely of independent directors to review employee compensation plans on at least a semi-annual basis.
  • Private companies that received $25 million or less of TARP assistance are not required to create a separate Board Compensation Committee provided the full Board carries out the same duties.
  • Retroactive Review of Prior Bonuses. Treasury will review bonuses, retention awards and other compensation paid to the top 5 senior executive officers and the next 20 most highly compensated employees of each entity receiving TARP assistance before February 17, 2009 to determine whether any payments were inconsistent with purposes of the Stimulus Act.
    • Treasury may seek reimbursement from the TARP recipient if Treasury determines the payments were not in keeping with the purposes of the Stimulus Act.

+500,000 Tax Deduction Cap. Participants in TARP are subject to the provisions of Internal Revenue Code section 162(m)(5) limiting the deduction of compensation to $500,000 per year for senior executive officers.

+Policy on Luxury Expenditures. The Board of Directors of any TARP recipient must have in place a company-wide policy regarding excessive or luxury expenditures, as identified by Treasury.

+Annual Shareholder “Say on Pay” Vote. Any proxy or consent or authorization for an annual or other meetings of the shareholders of any TARP recipient during the period in which any obligation arising under TARP remains outstanding must permit a separate shareholder “say on pay” vote to approve the compensation of executives.

  • The shareholder vote is not binding on the Board of Directors and may not be construed as overruling a decision by the Board or as creating any additional fiduciary duty for the Board. In essence, this shareholder vote requirement is a disclosure requirement.

+Required Certification by CEO and CFO. The CEO and CFO (or their equivalents) of each company receiving bailout money must provide written certification of compliance with the executive compensation limits in the Stimulus Act to the SEC (public companies) or to Treasury (private companies).

+Early Repayment Explicitly Permitted. Subject to consultation with their respective Federal banking regulator, TARP participants may repay assistance previously received under TARP without replacing the funds from other sources and without regard to otherwise applicable waiting periods.

-This is a change to Treasury’s prior requirement that banks receiving money from the capital injection program keep the money for three years or raise private capital to replace the funds.

Industry leaders have raised questions about the application of the executive compensation limits. The Stimulus Act says that TARP recipients must abide by standards to be set by Treasury. It is unclear whether the compensation limits go into effect before Treasury adopts the required standards. The American Bankers Association has written a letter to Treasury stating that the ABA interprets this directive to Treasury to mean the executive compensation limits are not effective until Treasury establishes standards. We are monitoring the issues surrounding these new executive compensation restrictions as well as the ever-changing government economic stimulus and bailout plans and pronouncements.

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