Compensation and Corporate Governance Standards for TARP Recipients: Key Highlights of the Interim Final RuleJune 18, 2009
Effective Date. The Interim Final Rule is effective as of June 15, 2009. Many compliance deadlines fall on September 14, 2009, or 90 days after closing of a TARP financing, whichever is later.
- Not Completely Retroactive. Interestingly, not all portions of the Interim Final Rule are retroactive, as many practitioners anticipated. For example, the bonus payment limitations under the Interim Final Rule generally do not apply to amounts paid or accrued prior to June 15, 2009, or to amounts as to which there was a legally binding right as of February 11, 2009.
Single TARP Authority. The Interim Final Rule supersedes all previous TARP guidelines except for the guidance under Code Section 162(m)(5), which limits the deductible compensation for Senior Executive Officers ("SEOs") to $500,000.
TARP Recipients. The Interim Final Rule applies to TARP recipients, which generally includes the entity directly receiving financial assistance under TARP and any entities related to such entity (using Code Section 414 principles but with a 50% ownership threshold) ("TARP Recipients"). An anti-abuse rule provides that the TARP restrictions may apply to an entity if the primary purpose of such entity was to avoid or evade the TARP restrictions.
TARP Period. As before, the restrictions only apply to TARP Recipients while such recipient has an outstanding financial obligation to Treasury, excluding an obligation under a warrant ("TARP Period").
Reliance on Federal Securities Laws for Definitions. Even for private institutions, the Interim Final Rule relies on federal securities laws for defining several terms. For example, "annual compensation," "perquisites," and "incentive plan" are all defined by reference to federal securities laws. This will require private institutions to calculate compensation in certain instances as if they were subject to federal securities regulation.
Determination of SEOs and other Affected Employees. The TARP restrictions apply to (i) SEOs and (ii) up to the next twenty most highly compensated employees. "Annual compensation" for the prior fiscal year is what determines whether an employee will be covered by applicable restrictions. Annual compensation is defined by reference to the amounts that would be required to be disclosed under the comprehensive compensation disclosure provisions of Item 402 of Regulation S-K of the federal securities laws if the person were a named executive officer includible in the proxy, even if the TARP Recipient is not regulated by the SEC. These rules generally require disclosure of all salary, bonus, stock awards, option awards, perquisites and other types of compensation
- SEOs. Similar to prior law, the SEOs are the principal executive officer, the principal financial officer, and the next three most highly compensated executives.
B. Office of the Special Master
Creation of the Office of the Special Master. The Interim Final Rule establishes an Office of the Special Master for TARP Executive Compensation. For all TARP recipients, the Special Master will:
- interpret the application of the restrictions on executive compensation;
- will review whether payments made prior to February 17, 2009 were in the public interest (as required pursuant to Section 111(f) of the Emergency Economic Stabilization Act of 2008("EESA"), as amended by the American Recovery and Reinvestment Act of 2009 ("ARRA"),
- will provide opinions, as requested or as otherwise appropriate, regarding payments to employees or the general compensation structure of TARP recipients; and
- will fulfill other functions, as delegated by the Secretary, relating to executive compensation for TARP recipients.
C. Tarp Limitations Created or Interpreted under the Interim Final Rule
Employees Subject to Bonus Payment Restrictions. The number of employees subject to the bonus payment restrictions depends upon the amount of TARP funds received by the TARP recipient. The restriction applies based on the total aggregate amount of TARP funds received if the TARP recipient has received TARP funds more than once. The employees subject to the bonus payment restrictions are as follows:
Tarp Funds Employees (Subject to Bonus Restriction)
- Less Than $25 Million (Single most highly compensated employee)
- $25 Million - $250 Million (Top five most highly compensated employees*)
- $250 Million - $500 Million (SEOs and the next ten most highly compensated employees
- $500 Million or more (SEOs and the next twenty-five most highly compensated employees*)
* For TARP recipients receiving more than $25 million, Treasury has reserved the right to apply the bonus limitations to more than the number of employees listed above.
Bonus Payment Restrictions. Bonuses, incentive payments, and retention awards ("Bonus Payments") may not be paid to the employees listed above. Bonuses are defined as payments made in addition to amounts payable to an employee for services performed at a regular hourly, daily, weekly, or similar periodic rate. Incentive payments are those made under an incentive plan as defined in Regulation S-K under the federal securities laws or under any plan providing for stock options or other equity based compensation, like restricted stock units or stock appreciation rights. Therefore, affected employees may not receive awards of equity-based compensation like stock options, restricted stock, restricted stock units or stock appreciation rights, unless the award meets the requirements for long-term restricted stock, as set forth below. The following are generally not Bonus Payments:
- Contributions to qualified plans (as defined in section 4974(c) of the Internal Revenue Code);
- Benefits under a broad-based benefit plan;
- Bona-fide overtime pay;
- Commissions meeting the Interim Final Rule's definition of "commission compensation";
- Bona fide and routine expense reimbursements; and
- Long-term restricted stock meeting the Interim Final Rule's definition of "long-term restricted stock."
An anti-abuse provision prevents the TARP recipient from delaying a payment or providing retroactive service credits for an employee that is subject to the restrictions on Bonus Payments.
Bonus Alternatives. In light of the bonus payment restrictions, the following alternatives are available:
Long-term restricted stock. There is an exception for Bonus Payments if issued in the form of "long-term restricted stock." "Long-term restricted stock" has the following features:
- The value of the long-term restricted stock cannot exceed 1/3 of the employee's annual compensation for the year of the award, valuing the stock at the grant date value and ignoring any vesting requirements. For example, if an employee received a $300,000 long-term restricted stock grant subject to a three-year vesting period, then the entire grant is included in the limitation calculation in the year of the grant even though the stock is subject to vesting.
- Long-term restricted stock must generally be issued in common stock or an analogous unit (for non-stock corporations).
- The stock must be subject to transfer restrictions until the TARP recipient has repaid certain levels of TARP assistance, although shares are transferable earlier for the purposes of satisfying tax withholding requirements.
- The employee must also be subject to at least a 2-year service requirement for vesting, even if the TARP assistance will be repaid prior to the expiration of the 2-year period.
Equity as Salary. The Interim Final Rule permits employees to receive stock (or phantom stock units) as salary. This allows TARP recipients to provide equity participation for top executives, despite the bonus payment restrictions. The stock may not be subject to restrictions except for transfer or holding period restrictions. In other words, the stock may not be subject to a substantial risk of forfeiture or a requirement for continued employment, although the employer can impose a required holding period and restrictions on transfer. Paying equity as additional salary may also be attractive since it increases the amount of long-term restricted stock that can be issued.
Grandfather Provisions for Bonuses/Potential Delay of Grandfathered Payments. Bonus Payments that are required to be paid under a written employment contract entered into prior to February 11, 2009 may be paid without regard to the Bonus Payment restrictions discussed above. Treasury has reserved the right to delay any grandfathered Bonus Payments until TARP has been repaid or other conditions, such as those relating to financial health, have been satisfied. Treasury advises that such delay will not result in a failure to comply with Section 409A. In addition certain Bonus Payments accrued or paid prior to June 15, 2009 are allowable.
Claw-back Provisions. The SEOs and the next twenty most highly compensated employees are subject to bonus claw-back provisions if a bonus is paid on the basis of performance metrics that are later determined to be materially inaccurate.
Golden Parachute/Severance Restrictions. The SEOs and the next five most highly compensated employees (a total of 10 employees) are prohibited from receiving severance payments and change of control payments (even if not triggered by separation of service) during the TARP Period. Also prohibited are accelerated vesting of equity awards in both the severance and change of control contexts. The Interim Final Rule provides that all payments are treated as being paid at the time of departure, so a delayed payment will be treated as received during the TARP Period. In other words, delaying the payment is not an effective way to circumvent the severance restrictions on TARP Recipients. Certain payments are not covered by these restrictions. These include payments under tax-qualified plans or payments made by reason of termination of employment for death or disability.
Disclosure of Executive Perquisites. TARP recipients must annually disclose any executive perquisites with a total value exceeding $25,000 for any executives covered by the Bonus Payment restrictions. A "perquisite" is defined as a benefit where the item is required to be included in the amount reported under Item 402(c)(2)(ix)(A) of Regulation S-K of the federal securities laws. The disclosure must be accompanied by a narrative description describing and justifying the perquisites. The disclosure must be submitted to Treasury and the primary regulator within 120 days after the completion of the TARP recipient's fiscal year.
Prohibition on Tax Gross-Ups. All TARP recipients are prohibited from providing tax gross-up payments for perquisites, change of control payments or otherwise to the SEOs or the next twenty most highly compensated employees. An anti-abuse rule prevents deferred payment of tax gross-ups.
Luxury Expenditure Policy/Posting on Website. Within 90 days of closing, or September 14, 2009 (whichever is later), all TARP recipients must develop a luxury expenditure policy, file it with Treasury, and post it to the TARP recipient's website (if one is maintained). Examples of luxury expenditures include excessive expenditures on entertainment, events, travel, or office and facility renovations. The luxury expenditure policy must identify prohibited expenditures or expenditures requiring approval, adopt an approval process for expenditures requiring approval, mandate prompt internal reporting of any violation of the policy, and require accountability for adherence to the policy. The principal executive officer and the financial executive officer must certify that a proper expenditure policy has been adopted and certify compliance with the policy.
Acquisitions. An entity (the "acquirer") acquiring a TARP recipient (the "target"), no matter the acquisition form, will not automatically become subject to the TARP executive compensation restrictions unless a primary purpose of the acquisition was to avoid the TARP limitations. This means that the employees of the acquirer after the acquisition (including the former target employees) will not be subject to the TARP limitations on compensation unless the anti-abuse rule applies.
Say-on-Pay. The Interim Final Rule requires a separate shareholder vote to approve compensation of executives. The TARP recipient must comply with any regulations, rules, or guidance promulgated by the SEC in implementing the "say-on-pay" requirement. We believe private institutions should not have to comply with the "say-on-pay" provision.
Compensation Consultant Disclosure. All TARP recipients must annually provide a narrative description of whether a compensation consultant was used and, if so, a description of all services provided by that consultant or any of its affiliates (including non-compensation related services) for the past three years, including the use of benchmarks or other comparisons used to identify compensation levels. The disclosure must be submitted to Treasury and the primary regulator within 120 days after the completion of the TARP recipient's fiscal year.
Establishment of Compensation Committee with Independent Directors. Within 90 days of closing, or September 14, 2009 (whichever is later), the TARP Recipient must establish a compensation committee with independent directors, whose independence is determined pursuant to Item 407(a) of Regulation S-K of the federal securities laws. The TARP Recipient must generally maintain the compensation committee once it has been established. A private bank that has received less than $25 million in TARP assistance may, in lieu of establishing a compensation committee, have the board of directors perform the compensation review.
Risk Review by the Compensation Committee or Board. At least every six months, the compensation committee (or the board in the case of private banks receiving less than $25 million) should meet with senior risk officers to:
- Review Risks. Identify any risks that the TARP Recipient faces that could threaten the value of the TARP Recipient, including long-term and short-term risks.
- Review SEO Compensation. Identify and limit any compensation features that could lead SEOs to take unnecessary and excessive risks that would threaten the safety and soundness of the TARP Recipient, including any compensation features that would encourage a focus on short-term results rather than long-term value.
- Review Other Employee Compensation. Review whether any employee compensation plans create or encourage risks that threaten the safety and soundness of the TARP Recipient, including any compensation features that would encourage a focus on short-term results rather than long-term value.
- Discourage Earnings Manipulation. Review compensation plans and eliminate any features that could encourage manipulation of reported earnings to enhance the compensation of any employee.
The compensation committee (or board) must prepare a narrative description of its review and must certify its review in a disclosure submitted (i) as a part of the Compensation Committee Report required under federal securities laws (for public institutions) or (ii) to Treasury and the primary regulator within 120 days after completion of the TARP Recipient's fiscal year (for private institutions).
Annual Certification by the Principal Executive Officer and Principal Financial Officer. Within 90 days after the completion of the TARP Recipient's fiscal year, the TARP recipient's principal executive officer ("PEO") and principal financial officer ("PFO") must certify compliance with the Interim Final Rule. The requirements for this certification are quite detailed, and must be submitted under penalty of perjury. Among other things, the PEO and PFO must certify that:
- The compensation committee (or board for private institutions receiving less than $25 million) has met semiannually and reviewed compensation as required under the Interim Final Rule;
- Certain employees have agreed to claw-back provisions if any Bonus Payments are paid on the basis of materially inaccurate performance metrics;
- Severance payments for certain employees have been prohibited;
- Bonus Payments for certain employees have been limited as required;
- The TARP Recipient has or will permit a non-binding shareholder resolution, regarding executive compensation, in accordance with any guidance, rules, and regulations promulgated by the SEC;
- A luxury expenditure policy has been adopted, maintained, and disclosed as required;
- Necessary disclosures for executive perquisites have or will be made;
- Necessary disclosures for the use of a compensation consultant have or will be made;
- Tax gross-ups for certain employees have been prohibited; and
- Substantial compliance with the agreement between Treasury and the TARP recipient has occurred.
The annual certification must also disclose the identities the SEOs and certain highly compensated employees, and must include a statement that the certifying officers understand that a knowing and willful false or fraudulent statement made in connection with the certification may be punished by fine, imprisonment, or both.
Recordkeeping. TARP recipients must preserve appropriate compliance documentation for at least six years, with the first two years kept in an easily accessible place.