TARP Capital Purchase Program – Summary of Executive Compensation Requirements
Pursuant to authority granted under Section 111 of the Emergency Economic Stabilization Act of 2008 (EESA), the U.S. Treasury Department has announced a voluntary Capital Purchase Program (CPP) to encourage eligible U.S. financial institutions to build capital to increase the flow of financing to U.S. businesses and consumers and to support the U.S. economy. Under the CPP, Treasury will purchase senior preferred stock (along with common stock warrants for publicly traded institutions and preferred stock warrants for non-publicly traded institutions) from participating financial institutions. The minimum subscription amount is 1% of risk-weighted assets; the maximum subscription amount is the lesser of $25 billion or 3% of risk-weighted assets. If a financial institution participates in the CPP, it must adopt Treasury's standards for executive compensation, which are summarized below:
Timing: The financial institution will need to comply with the standards for executive compensation by the date Treasury purchases the preferred stock, and will need to maintain compliance with such standards throughout the period during which Treasury holds any equity (including warrants) or debt of the financial institution issued under the CPP (CPP period).
- By closing, the financial institution must (1) adopt amendments to its compensation, bonus, incentive and other benefit plans, arrangements and agreements (including golden parachute, severance and employment agreements) (the “benefit plan amendments”) which comply with the standards, (2) obtain waivers from SEOs (described below) waiving any claims against Treasury (in the form of an exhibit to the Treasury’s standardized Securities Purchase Agreement), (3) obtain a consent of each SEO (where unilateral action by the financial institution is not sufficient to ensure enforceability) agreeing to the benefit plan amendments and (4) obtain waivers from SEOs waiving any claims against the financial institution for implementing the benefit plan amendments and other CPP executive compensation standards.
Who is covered: The standards apply to the financial institution’s Senior Executive Officers (SEOs), defined generally as the CEO, CFO and the next three most highly compensated executive officers. This is the same definition as for the Named Executive Officers (NEOs) in the proxy statement, except that the determination is made based on the current fiscal year, rather than the last completed fiscal year.
- The financial institution will need to determine its current SEOs based on year-to-date 2008 compensation information.
- The list of SEOs may change during the course of a year (just as the list of NEOs changes from year to year); any new SEO will become subject to the same standards and will need to sign the same waiver and consent as other SEO
What are the standards:
- Risk review by Compensation Committee.
- Within 90 days of Treasury’s purchase of the preferred stock, the financial institution’s compensation committee must review all SEO bonus and incentive compensation arrangements with the financial institution’s senior risk officers to ensure that such compensation does not encourage SEOs to take “unnecessary and excessive risks that threaten the value of the financial institution.”
- During the CPP period, the compensation committee must complete a similar review annually and certify in each annual proxy statement Compensation, Discussion and Analysis (CD&A) that it has completed this annual review and state that it has made reasonable efforts to ensure that such compensation does not encourage SEOs to take unnecessary and excessive risks that threaten the value of the financial institution.
- Treasury’s current guidance states that each institution’s material risks are unique and it is the compensation committee’s responsibility to identify features present in SEO compensation arrangements that could lead to risky behavior and limit these elements.
- Clawback. The financial institution must make any bonus or incentive compensation paid to an SEO during the CPP period subject to recovery if the payment was based on materially inaccurate financial statements or other performance metric criteria that are later proven to be materially inaccurate.
- There is no limit to the recovery period for any bonus or incentive payment made during this period.
- Prohibition on excess parachute payments. During the CPP period, the financial institution is prohibited from making an excess parachute payment to an SEO.
- “Excess parachute payment” means any compensation payment to (or for the benefit of) an SEO made during an applicable taxable year on account of an applicable severance if the aggregate present value of such payments equals or exceeds 3 times the SEO’s base amount (generally, the SEO’s average annual taxable W-2 compensation for the last 5 consecutive years).
- “Applicable severance” means any involuntary termination of the SEO by the financial institution, including (i) severance due to the unilateral act of the financial institution to terminate the SEO’s employment (other than at the SEO’s implicit or explicit request), where the SEO is willing and able to continue performing services; (ii) the financial institution’s failure to renew a contract at the time such contract expires, provided the SEO was willing and able to execute a new contract providing terms and conditions substantially similar to those in the expiring contract and able to continue providing such services; (iii) an SEO’s voluntary termination if constitutes a termination for good reason due to a material negative change in SEO’s employment relationship; and (iv) voluntary termination by SEO in any case where circumstances indicate that absent such voluntary termination the financial institution would have terminated the SEO’s employment and the SEO had knowledge that he or she would be so terminated.
- This prohibition applies to all payments that would not have been payable if no applicable severance had occurred (including amounts that would otherwise have been forfeited due to severance) and amounts that are accelerated on account of the severance (but excludes any payments under a tax-qualified retirement plan).
- Limitation on deductions. The financial institution must agree that it will not claim a federal income tax deduction for executive compensation in excess of $500,000 for each SEO during the CPP period.
- Unlike current IRC Section 162(m) (which limits non-performance based compensation in excess of $1,000,000), the new $500,000 deduction limit would apply 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 CPP period (applied on an earned and vested basis, i.e., payments earned and vested prior to the CPP period but paid during the CPP period are not limited by the new deduction limit; conversely, payments earned and vested during the CPP period but paid after the CPP period would be limited by the new deduction limit).
- An SEO remains an SEO for the entire CPP period for purposes of the deduction limit.
- The financial institution’s agreement would be made through a representation or covenant by the financial institution in the standardized purchase agreement.
- Waivers by the Financial Institution and SEOs. The financial institution and each SEO must execute a waiver of any claims either may have against Treasury, and each SEO must execute a waiver of any claims he or she may have against the financial institution, relating to compliance with the CPP executive compensation standards.