I. Treasury and SEC Statements on Executive Compensation
On June 10, 2009, Timothy F. Geithner, Secretary of the U.S Department of the Treasury (Treasury), and Mary L. Schapiro, Chairwoman of the SEC, each released a statement concerning executive compensation. The releases followed a meeting on executive compensation among Mr. Geithner, Ms. Schapiro, and Daniel Tarullo, member of the Federal Reserve Board of Governors.
Statement From Treasury. Mr. Geithner’s statement identified executive compensation practices as a “contributing factor” in the financial crisis and set out five “broad-based principles” intended to “better align compensation practices with sound risk management and long-term growth.” The five principles are as follows:
Citing these principles, Mr. Geithner’s statement indicated that he intends to support “say on pay” legislation in Congress, “giving the SEC authority to require companies to give shareholders a non-binding vote on executive compensation packages,” and to propose legislation giving the SEC the power to ensure that compensation committees are more independent, “adhering to standards similar to those in place for audit committees as part of the Sarbanes-Oxley Act,” and giving compensation committees the responsibility and resources to hire their own independent compensation consultants and outside counsel.
Mr. Geithner’s statement promised that the President’s Working Group on Financial Markets will review compensation practices annually to monitor whether they are creating excessive risks and encourage experts in the field to conduct their own reviews. The statement also expressed support for Federal Reserve Chairman Benjamin S. Bernanke and bank supervisors’ efforts to “lay out broad standards on compensation that will be more fully integrated into the supervisory process.”
The statement was accompanied by two “fact sheets” with additional information on the legislation intended to implement the principles outlined in the statement.
The SEC also would be required to establish standards for ensuring the independence of compensation consultants and outside counsel used by the compensation committee.
Statement From the SEC. Ms. Schapiro’s statement indicates that the SEC intends to consider several proposals requiring additional proxy statement disclosure concerning compensation of publicly traded companies. The proposals will concern disclosure about the following:
II. New Guidance on Executive Compensation Rules Under TARP
Also on June 10, 2009, the Treasury released an Interim Final Rule (the Interim Final Rule) on the Troubled Assets Relief Program (TARP) Standards for Compensation and Corporate Governance. The Interim Final Rule is intended to implement fully the executive compensation and corporate governance requirements established under Section 111 of the Emergency Economic Stabilization Act of 2008 (EESA), as amended by the American Recovery and Reinvestment Act of 2009 (ARRA), and to supersede all prior rules and guidance under these provisions. The Treasury has invited comments on the Interim Final Rule; any comments must be submitted by 60 days after the Interim Final Rule is published in the Federal Register.
Effective Date and Scope. The Interim Final Rule is generally effective upon its publication in the Federal Register, except with respect to the sections of the ARRA amendments that were, by their terms, immediately effective. The requirements of Section 111 of EESA and the Interim Final Rule apply generally to any “TARP recipient,” defined in Section 111(a)(3) of EESA as “any entity that has received or will receive financial assistance under the financial assistance provided under the TARP.” The Interim Final Rule clarifies that “financial assistance” generally includes only direct financial transactions between the Treasury and private sector participants in programs under the TARP. Entities that are not party to a direct financial transaction with Treasury — such as those that post collateral to and receive loans from the Federal Reserve Term Asset-Backed Securities Loan Facility — would not be deemed to receive “financial assistance” for these purposes.
Independent Compensation Committee Required. Consistent with Section 111 of EESA, the Interim Final Rule requires TARP recipients to establish a compensation committee composed of independent members of the board of directors by the later of 90 days after the closing date of the agreement between the Treasury and the TARP recipient or 90 days after the effective date of the Interim Final Rule. There is an exception for non-publicly traded TARP recipients that have received $25 million or less in financial assistance; such entities may either establish an independent compensation committee or delegate to the board of directors the compensation committee duties.
Risk Assessment. The Interim Final Rule requires the compensation committee of each TARP recipient to discuss, evaluate, and review at least every six months with the company’s senior risk officers (i) the compensation plans applicable to the TARP recipient’s senior executive officers (SEOs) to ensure that such plans do not encourage the SEOs to take unnecessary and excessive risks that could threaten the value of the TARP recipient and (ii) the compensation plans applicable to the TARP recipient’s employees generally in light of the risks posted to the TARP recipient by such plans and how to limit such risks. (The SEOs are generally the “named executive officers” as determined in accordance with the SEC’s proxy disclosure rules.) The compensation committee also must discuss, evaluate, and review at least every six months the compensation plans applicable to the TARP recipient’s employees to ensure that the plans do not encourage the manipulation of reported earnings to enhance the compensation of any employee. As part of its discussion, evaluation, and review, the compensation committee is expected to identify problematic features in its compensation plans, including features that would encourage behavior focused on short-term results and not on long-term value creation, and limit or eliminate such features.
The compensation committee must provide annually a narrative description of how its plans comply with these requirements and how risk has been limited and certify annually that it has completed the required reviews of the SEO and employee compensation plans. For public companies, the required disclosures and certifications must be included in the companies’ annual proxy statements in their compensation committee reports. Other companies must provide the required disclosures and certifications to their primary regulatory agency and to the Treasury.
Clawback Policy. Consistent with Section 111 of EESA, the Interim Final Rule requires TARP recipients to ensure that any bonus, retention award, or incentive compensation paid to or earned by an SEO or any of the next 20 most highly compensated employees of the TARP recipient be subject to recovery if the bonus payment was based on materially inaccurate financial statements or any other materially inaccurate performance metric criteria. The Interim Final Rule clarifies that the “most highly compensated employees” are not limited to executive officers, but may include non-executive-officer employees.
Golden Parachute Payments. Consistent with Section 111 of EESA, the Interim Final Rule generally prohibits any golden parachute payments to an SEO or any of the next five most highly-compensated employees of the TARP recipient. Golden parachute payments include payments for departure from a company for any reason, except for payments for services performed or benefits accrued. The Interim Final Rule also treats as a golden parachute payment any amount due upon a change in control event of the TARP recipient. The Interim Final Rule deems golden parachute payments to be paid at the time of the employee’s departure regardless of when amounts are actually paid, so the restriction cannot be avoided by deferring payment until after the TARP recipient has repaid its TARP funds.
Bonuses, Retention Awards, and Other Incentive Compensation. Section 111 of EESA and the Interim Final Rule prohibit TARP recipients from paying or accruing any bonus, retention award, or other incentive compensation, except (i) in the form of “long-term” restricted stock that does not exceed one third of the total annual compensation of the employee and does not “fully vest” while the TARP aid is outstanding or (ii) pursuant to valid employment contracts under which the employee had a legally binding right to such bonus, retention award, or other incentive compensation as of February 11, 2009.
The number of employees subject to the bonus prohibition depends on the amount of TARP funds received by the TARP recipient:
Definitions of “Bonus,” “Retention Award,” and “Incentive Compensation.” The Interim Final Rule defines a bonus as any payment in addition to any amount payable to an employee for services performed by the employee at a regular periodic rate. Certain commission compensation for sales to, and investment management services for, unrelated parties that is consistent with an arrangement in effect as of February 17, 2009 may not be deemed a bonus for these purposes. Incentive compensation is generally defined by reference to securities regulation definitions, but also includes most types of awards under stock option or stock plans even if such awards are not subject to performance-based vesting. A retention award is defined, subject to certain exceptions, as any payment that is not payable periodically for service performed at a periodic rate, is contingent on the completion of a period of future service with the TARP recipient (or the completion of a specific project or other activity of the TARP recipient) and is not based on the performance of the employee or the TARP recipient.
Definition of “Long-Term Restricted Stock” and “Fully Vested.” The Interim Final Rule defines restricted stock to include both restricted stock and restricted stock units and provides details on the calculation of the one-third of annual compensation limitation. In addition, the Interim Final Rule provides that, for each 25 percent of total financial assistance repaid, 25 percent of total long-term restricted stock granted may become transferable without being deemed fully vested. Once a final repayment occurs, the remaining long-term restricted stock may become repayable. The Interim Final Rule also requires that employees provide services through the second anniversary of the grant date of the restricted stock, and provides an exception to the transferability restrictions to the extent necessary to pay applicable taxes.
“Luxury” Expenditures. Consistent with Section 111 of EESA, the Interim Final Rule requires boards of directors of TARP recipients to adopt excessive or luxury expenditures policies, file them with the Treasury and post them on their Web sites. Such a policy must require include standards to ensure appropriate review and approval of potentially excessive and luxury expenditures and must (i) identify the types and categories of expenses prohibited or requiring prior approval; (ii) adopt approval procedures; (iii) mandate certification by the principal executive and principal financial officers of prior approval of expenditures of any SEO, other similar executive officers, or the board of directors; (iv) mandate prompt internal reporting of any policy violation; and (v) mandate accountability for adherence to the policy. TARP recipient boards of directors will be required to determine which expenditures constitute excessive and luxury expenditures.
Say on Pay. The Interim Final Rule requires compliance with the say on pay requirements of the SEC.
Perquisites and Compensation Consultant Disclosures. The Interim Final Rule requires TARP recipients to disclose and justify to the Treasury and their primary federal regulators annually any perquisites valued at more than $25,000 for any employee subject to the TARP bonus limitations as well as to disclose information about their compensation committees’ engagement of compensation consultants.
Tax Gross Ups. The Interim Final Rule generally prohibits TARP recipients from providing tax gross-ups or other reimbursements for the payment of taxes to any of the SEOs or the next 20 most highly compensated employees.
Certification Requirement. The principal executive officer and the principal financial officer of each TARP recipient will be required to certify within 90 days of the end of each fiscal year as to the TARP recipient’s compliance with the requirements of the Interim Final Rule. The certification will be required as an exhibit to publicly traded TARP recipients’ Form 10-K filings and, for all TARP recipients, must be provided to the Treasury.
“Special Master” for TARP Executive Compensation. The Interim Final Rule requires TARP recipients receiving exceptional financial assistance to submit to the Office of the Special Master for TARP Executive Compensation for approval the compensation payments and compensation structures of their SEOs and other most highly compensated employees subject to the bonus limitation and the compensation structures of all other executive officers and 100 most highly compensated employees. TARP recipients limiting annual compensation to $500,000, with any additional compensation in the form of long-term restricted stock, are exempt from this requirement. The Special Master, who will be appointed by the Secretary of Treasury, also will be empowered to provide guidance and opinions and interpret the application of restrictions and requirements of and under TARP.
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Joshua A. Agen
Jay O. Rothman