On February 4, 2009, the Treasury Department issued a new set of executive compensation guidelines for financial institutions and other companies participating in the Troubled Asset Relief Program (TARP). The guidelines impose substantial new restrictions on executive compensation programs for both senior and lower level executives of such institutions.
In general, the new requirements apply prospectively only although certain certification requirements will apply to institutions that are currently participating in TARP. The new guidelines leave many questions unanswered, including their effect on advance TARP guidance previously issued by Treasury in the final days of the Bush administration, which has neither been formally published nor withdrawn and remains subject to an Obama administration hold order.
Although the new Treasury guidelines are currently limited to financial institutions participating in TARP, they give effect to a number of proposals long sought by activist shareholder groups for publicly traded corporations of all types, and potentially implicate corporate governance best practices and trends even for companies that do not and never intend to participate in TARP. In addition, as discussed below, the new guidelines specifically call for certain regulatory reforms that would impact all public financial institutions, not just those participating in TARP programs.
New Certification Requirements for Existing and Future TARP Participants
The new guidelines require the chief executive officer of each financial institution or other company that has received or will receive any form of government assistance under TARP to certify in writing on an annual basis that the CEO’s company has strictly complied with all TARP-related executive compensation requirements. The guidelines do not explain to whom the certification must be made, the precise contents of the certification, the penalties for non-compliance or how the proposed CEO certification structure relates to the structure previously announced by Treasury in guidance currently subject to the Obama administration hold order.
The new guidelines also require the compensation committee of any financial institution or other company receiving government assistance under TARP to explain how their senior executive compensation arrangements do not encourage excessive and unnecessary risk taking. The guidelines do not explain when, where or to whom this explanation must be made, or how it differs from the existing proxy certification requirement for compensation committees in the original TARP guidance released in October 2008.
New Executive Compensation Restrictions for Future TARP Participants
The guidelines impose new executive restrictions that will apply prospectively to future TARP participants or current TARP participants that take future government money under TARP. The restrictions depend on whether the financial institution or other company is receiving “exceptional financial recovery assistance” or is participating in a “generally available capital access program” instead. The guidelines do not precisely define the difference between the two categories, although they suggest the difference lies in whether a company requires more assistance than the assistance that is available under a widely available, standardized program, such as the Capital Purchase Program.
A. Requirements for “Exceptional” Financial Recovery Assistance Programs
The new executive compensation requirements for financial institutions and other companies receiving “exceptional financial recovery assistance” are as follows.
- $500,000 Cap on Annual Compensation Paid to the Company’s Senior Executive Officers. Under prior TARP guidance a company was free to pay compensation to a senior executive officer of any amount, but could not deduct more than $500,000 per year for each senior executive officer. The new guidelines exclude restricted stock and “other similar long-term incentive arrangements” from the $500,000 cap as long as vesting of the awards is tied to the company’s repayment of government-issued TARP funds. The guidelines do not define “other similar long-term incentive arrangements” or explain the exact conditions under which vesting of the restricted stock awards would be allowed. In addition, they do not address certain technical questions, such as the manner for determining the senior executive officers for this purpose and how the limit would apply to deferred compensation.
- “Say-on-pay” Resolution Must be Presented to Shareholders. A company receiving exceptional assistance must present a resolution to a non-binding shareholder vote regarding its senior executive compensation structure and the “rationale for how compensation is tied to sound risk management.”
- Additional Clawback Requirements. A company receiving exceptional assistance must “have in place provisions” to claw back bonuses and other incentive compensations for twenty additional officers in addition to the five senior executive officers, if such officers have knowingly engaged in providing inaccurate information relating to financial statements or performance metrics on which their incentive compensation is based. The guidelines do not explain how the twenty additional officers would be identified.
- Total Ban on Golden Parachute Payments for Top 10 Executives. In addition to the top 10, the “next” twenty-five officers would have golden parachute payments capped at one-time base salary. The guidelines do not define “golden parachute” but presumably this is intended to match the definition in existing TARP guidance, which covers involuntary severance payments. Again, no method for identifying the “next” twenty-five officers is provided.
- Required Policy on “Luxury Expenditures.” The board of directors of a company receiving “exceptional” TARP assistance must adopt a company-wide policy relating to the approval of any “luxury” expenditures, including aviation services, office renovations, parties, conferences and other events.
B. Requirements for “Generally Applicable” Capital Access Programs
The new executive compensation requirements for financial institutions and other companies participating in “generally applicable capital access programs” are generally the same as for companies receiving “exceptional” assistance, except that:
- the $500,000 cap on SEO pay can be waived by (i) disclosing the compensation (which public companies are required to do anyway under SEC rules, although it is unclear whether the new guidelines would require any additional disclosures), (ii) submitting the compensation to a non-binding shareholder “say-on-pay” vote, and (iii) disclosing why the compensation arrangements for all of its employees, not just its senior executive officers, do not encourage excessive and unnecessary risk-taking;
- a “say-on-pay” shareholder vote is not otherwise required; and
- golden parachute payments for the top 5 executive officers would be capped at one-time base salary, rather than banned completely, and there would be no restrictions on golden parachute payments for any other officers.
Treasury intends to issue future guidance subject to public comment on the new executive compensation requirements for companies participating in “generally applicable” capital access programs, but does not state a timeframe.
New Long-Term Regulatory Reform Proposals
In addition to the TARP-related requirements discussed above, Treasury has recommended that all financial institutions — not just those receiving TARP funds — be subjected to future regulatory requirements, including:
- Requiring compensation committees of all public financial institutions to review and disclose how the companies’ compensation programs are consistent with “promoting sounds risk management and long-term value creation” for the companies and their shareholders;
- Requiring top executives at financial institutions to hold stock for several years after it is awarded before it can be sold; and
- Requiring all public financial institutions to submit non-binding “say-on-pay” resolutions to their shareholders, regarding both the amounts of compensation paid and whether the compensation programs adequately address risk management concerns.
Stay-Tuned for More
These guidelines are likely the first wave in a range of further guidance from the Treasury Department on executive compensation restrictions. As noted above, additional guidance is already planned for companies participating in the “generally applicable” capital access program. In addition, there are a number of interpretative issues for companies that receive “exceptional financial recovery assistance.”
For additional information, please contact a member of the McGuireWoods Executive Compensation team.