American Recovery and Reinvestment Act of 2009 Summary of Executive Compensation Requirements
The American Recovery and Reinvestment Act of 2009, enacted February 17, 2009, rewrites Section 111 of the Emergency Economic Stabilization Act of 2008 (EESA) and provides modified rules for the Troubled Asset Relief Program (TARP) established under the EESA in a number of important ways.
Highlights
The Act:
- Expands the golden parachute payment prohibition to any payment related to any departure from the TARP recipient for any reason, except for payments for services performed or benefits accrued; and expands the prohibition to apply not just to SEOs, but also to the next 5 most highly-compensated employees.
- Expands the requirement of recovery of a bonus, retention award, or incentive compensation paid to a SEO and to the next 20 most highly-compensated employees of a TARP recipient based on statements of earnings, revenues, gains, or other criteria that are found to be materially inaccurate.
- Prohibits, with certain exceptions, a TARP recipient from paying or accruing any bonus, retention award, or incentive compensation to the SEOs and as many as 20 of the next most highly-compensation employees, or such higher number as the U.S. Treasury Department (the Treasury) may determine is in the public interest (depending on the amount of TARP assistance received).
- Prohibits any compensation plan that would encourage manipulation of the reported earnings of a TARP recipient to enhance the compensation of any of its employees.
- Clarifies the “TARP period” (i.e., the period in which any obligation arising from financial assistance provided under TARP remains outstanding) to exclude any period during which the federal government only holds warrants to purchase common stock of the TARP recipient.
- Directs the Treasury to review compensation paid to SEOs and the next 20 most highly-compensated employees before the date of the Act’s enactment to determine whether such payments were inconsistent with the provisions of TARP or the public interest, and to negotiate appropriate reimbursements to the federal government.
Definitions
The Act provides new or clarified definitions as follows:
- A “golden parachute payment” is defined as any payment to a senior executive officer for departure from a company for any reason, except for payments for services performed or benefits accrued. (Note, even though defined as payable to a SEO, the Act extends the golden parachute payment prohibition to any of the next 5 most highly-compensated employees in addition to SEOs.)
- A “senior executive officer” is defined as an individual who is one of the top 5 most highly-paid executives of a public company, whose compensation is required to be disclosed pursuant to the Securities Exchange Act of 1934, and any regulations issued thereunder, and non-public company counterparts.
- The “TARP period” is clarified by stating that the TARP period does not include any period during which the federal government only holds warrants to purchase common stock of the TARP recipient.
Executive Compensation Standards
The Act provides that during the TARP period, TARP recipients will be subject to the executive compensation standards established the Treasury, including the required standards contained in Section 111 of EESA (described below), and the applicable provisions of Section 162(m)(5) of the Internal Revenue Code which limit the deductibility for Federal income tax purposes to $500,000 for each SEO during the TARP period.
Deduction Limit
The deduction limit does not appear to have been changed and is summarized as follows:
- Unlike the regular IRC Section 162(m) limit (which limits non-performance based compensation in excess of $1,000,000), the $500,000 deduction limit applies to deferred compensation, as well as commission pay and performance-based compensation traditionally excluded from the calculation.
- The deduction limit applies to any taxable year (or portion of a taxable year) during the applicable financial assistance period (applied on an earned and vested basis, i.e., payments earned and vested prior to the applicable financial assistance period but paid during the applicable financial assistance period are not limited by the new deduction limit; conversely, payments earned and vested during the applicable financial assistance period but paid after the applicable financial assistance period would be limited by the new deduction limit).
- A SEO remains a SEO for the entire applicable financial assistance period for purposes of the deduction limit.
Treasury’s Executive Compensation Standards
1. No Incentives for SEOs to Take Unnecessary and Excessive Risk. The standards must include limits on compensation that exclude incentives for SEOs of the TARP recipient to take unnecessary and excessive risks that threaten the value of the TARP recipient during the TARP period.
2. Clawback. The TARP recipient must make any bonus, retention award, or incentive compensation paid to a SEO and any of the next 20 most highly-compensated employees of the TARP recipient subject to recovery if the payment was based on statements of earnings, revenues, gains, or other criteria that are later found to be materially inaccurate.
3. Prohibition on excess parachute payments. The TARP recipient is prohibited from making any golden parachute payment to a SEO or any of the next 5 most highly-compensated
employees of the TARP recipient during the TARP period.
4. Prohibition on paying or accruing bonuses, retention awards and incentive compensation payments. The TARP recipient is prohibited from paying or accruing any bonus, retention award, or incentive compensation during the TARP period.
- The prohibition applies based on the amount of TARP funds received by the TARP recipient:
- If less than $25 million, the prohibition applies only to the most highly-compensated employee.
- If at least $25 million, but less than $250 million, the prohibition applies to at least the 5 most highly-compensated employees (or such higher number as the Treasury may determine is in the public interest with respect to the TARP recipient).
- If at least $250 million, but less than $500 million, the prohibition applies to the SEOs and at least the 10 next most highly-compensated employees (or such higher number as the Treasury may determine is in the public interest with respect to the TARP recipient).
- If $500 million or more, the prohibition applies to the SEOs and at least the next 20 most highly-compensated employees (or such higher number as the Treasury may determine is in the public interest with respect to the TARP recipient).
- An exception to the prohibition is available for the payment of long-term restricted stock by such TARP recipient, provided that the long-term restricted stock:
- does not fully vest during the TARP period;
- has a value in an amount that is not greater than 1/3rd of the total amount of annual compensation of the employee receiving the stock (for example, if an executive’s annual compensation is $100,000, the bonus would be limited to restricted stock valued at $50,000, which would be 1/3rd of the total annual compensation of $150,000); and
- is subject to such other terms and conditions as the Treasury may determine is in the public interest.
- An exception to the prohibition is also available for any bonus payment required to be paid pursuant to a written employment contract executed on or before February 11, 2009, as such valid employment contracts are determined by the Treasury.
5. Prohibition on compensation plans that encourage manipulation of reported earnings. The TARP recipient is prohibited from maintaining any compensation plan that would encourage manipulation of the reported earnings of the TARP recipient to enhance the compensation of any of its employees.
6. Establishment of a Board Compensation Committee. The TARP recipient must establish a Board Compensation Committee, comprised entirely of independent directors, for the purpose of reviewing employee compensation plans. The Board Compensation 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 from such plans. If the TARP recipient received $25 million or less of TARP assistance and its common or preferred stock is not registered pursuant to the Securities Exchange Act of 1934, the duties of the Board Compensation Committee may be carried out by the board of directors of the TARP recipient.
Additional Requirements
Certifications
The CEO and CFO (or their equivalent) of the TARP recipient must provide a written certification of compliance by the TARP recipient with the requirements of Section 111 of EESA as follows:
- If the securities of the TARP recipient are publicly traded, to the Securities and Exchange Commission (SEC), together with annual filings required under the securities laws, or
- If the securities of the TARP recipient are not publicly traded, to the Treasury Secretary.
Limitation on luxury expenditures
The board of directors of the TARP recipient must impose a company-wide policy regarding excessive or luxury expenditures, as identified by the Treasury, which may include excessive expenditures on:
- 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.
Shareholder approval of executive compensation
The Act requires the TARP recipient to permit a separate shareholder vote to approve the compensation of executives, as disclosed pursuant to the compensation disclosure rules of the SEC, in any proxy or consent or authorization for an annual or other shareholders meeting during the TARP period. The Act provides that the shareholder vote is not binding on the TARP recipient’s board and may not be construed as overruling a decision by the board or as creating or implying any additional fiduciary duty by the board. In addition, any such vote will not be construed to restrict or limit the ability of shareholders to make proposals for inclusion in proxy materials related to executive compensation. The SEC is directed to issue final rules and regulations in this regard no later than one year after the date of enactment of the Act.
Review of prior payments to executives
The Act requires the Treasury to review bonuses, retention awards, and other compensation paid to the SEOs and the next 20 most highly-compensated employees of each TARP recipient before the date of enactment of the Act to determine whether any such payments were inconsistent with the purposes of this section or the TARP or were otherwise contrary to the public interest. If the Treasury makes a determination described in the preceding sentence, it must seek to negotiate with the TARP recipient and the subject employee for appropriate reimbursements to the federal government with respect to compensation or bonuses.
Ending status as a TARP recipient
The Act provides that, subject to consultation with the TARP recipient’s appropriate Federal banking agency (as defined in Section 3 of the Federal Deposit Insurance Act), if any, the Treasury must permit the TARP recipient to repay any assistance previously provided under the TARP to it, without regard to whether it has replaced those funds from any other source or to any waiting period. When the TARP assistance is repaid, the Treasury must liquidate the warrants associated with the assistance at the current market price.
Further Guidance Needed
While this client alert summarizes the requirements set forth in the Act, the text of the Act leaves open any number of questions which likely will be addressed, at least in part, by regulations and other guidance to be issued by the Treasury. Existing questions include those regarding which standards apply in the interim before regulations are adopted, how Treasury will define certain terms used in the Act, whether TARP recipients can increase the salaries of SEOs and non‑SEO highly-compensated employees in instances where bonuses, retention awards and incentive compensation are prohibited, and whether the non-binding shareholder vote is required before the SEC issues its final rules and regulations in that regard.