Treasury Amends TARP Executive Compensation Rules to Drop CD&A Disclosure and Clarify Duties of SEC Smaller Reporting Companies

The Treasury regulations for financial institutions participating in the troubled asset relief program (TARP) under the Emergency Economic Stabilization Act have been amended to require that the compensation committee’s certification be included in the committee’s report rather than in the Compensation Discussion & Analysis portion of SEC filings. Treasury also clarified that smaller reporting companies participating in the TARP must cover the five executive officers named in Item 402 (a) of Regulation S-K even though 402 (m) allows them to report the compensation of only three senior officers. In addition, Treasury mandated a new reporting requirement for the principal financial officer of a participating financial institution.

Treasury regs require the compensation committee to meet, within 90 days after a purchase under the program, with senior risk officers of the financial institution to ensure that the firm’s incentive compensation arrangements do not encourage senior executive officers to take unnecessary and excessive risks that might threaten the firm’s value. After that, the compensation committee must meet annually with senior risk officers to review the relationship between the financial institution’s risk management policies and the compensation arrangements. Also, the compensation committee must certify that they have done so in order to assure investors and taxpayers that the institutions are complying with the requirements.

The Treasury believes that it is more appropriate to require that the certification be included in the compensation committee report because the compensation committee prepares the report and is also making the required certifications. Management of the financial institution prepares the Compensation Discussion & Analysis, which does not directly address the operations and functions of the compensation committee.

The Treasury also clarified that the rules requiring clawback of any bonuses or incentive compensation paid during the period Treasury holds an interest in the financial institution apply to such compensation earned, but not paid, during the holding period. The Treasury believes that any bonus or incentive compensation earned during he Treasury holding period should be subject to clawback; and will consider any such compensation paid during the holding period when the senior officer obtains a legally binding right to that payment during the holding period.

Generally, the SEC requires disclosure of the executive compensation of the principal executive officer, principal financial officer and the other three most highly compensated senior officers. But for smaller reporting companies, the SEC requires disclosure of the compensation of the principal financial officer and the other two most highly compensated officers.

Treasury has clarified that, for purposes of participating in the TARP, a financial institution that is a smaller reporting company under SEC rules must identify five senior executive officers as subject to the TARP rules even though only three senior officers are provided in the disclosure pursuant to section 402 of Regulation S-K under the federal securities laws. Also, a financial institution that is a smaller reporting company should provide the certifications of the compensation committee in the same way a larger financial institution would do.

Treasury has also added a new compliance reporting regime relating to the executive compensation requirements earlier set forth under which the principal executive officer of the financial institution must provide certifications to the Chief Compliance Officer of the TARP. Specifically, within 120 days of the closing date of the securities purchase agreement between the financial institution and the Treasury, the principal executive officer must certify that the compensation committee has reviewed the incentive compensation arrangements with the firm’s senior risk officers to ensure that the arrangements do not encourage the taking of unnecessary and excessive risks that could threaten the value of the financial institution.

Also, within 135 days of the completion of each fiscal year during which the financial institution participated in the program, the principal executive officer must certify the following to the CCO: that the compensation committee has met at least once during the year with the senior risk officers to review the relationship between the risk management policies and the incentive compensation arrangements; that the compensation committee has certified to this review; that the financial institution has required that bonuses be subject to clawback; that golden parachutes are prohibited; and that the financial institution has limited the deduction for remuneration for federal income tax purposes to $500,000 for each senior executive officer as if section 162(m)(5) of the Internal Revenue Code applied to the financial institution.

The principal executive officer must either timely provide these certifications or explain to the TARP CCO why they have not been provided.

Financial institutions must preserve documentation and records to substantiate each certification for at least six years, the first two years in an easily accessible place. The financial institution must promptly furnish such documentation to the CCO on request.