Stimulus Bill Imposes Corporate Governance Standards and Say on Pay

The American Recovey and Reinvestment Act of 2009 (H.R. 1), as reported out of the conference committee and cleared for passagwe imposes various executive compensation limits on companies participating in the troubled assets relief program (TARP). The provisions also require each TARP recipient to include in its annual proxy statement a nonbinding shareholder advisory vote on the company’s executive cash compensation program. The Act further prohibits golden parachutes to senior executives. The Act imposes strong corporate governance mandates on TARP companies, including a requirement to have an independent compensation committee. In addition, it rescinds a controversial IRS ruling on acquisitions by financial institutions.

The provisions fall under a title of the bill added by Senate Banking Committee Chair Christopher Dodd. The Dodd Amendment applies strong executive compensation restrictions to all recipients of TARP funds, regardless of whether they receive a capital injection or sell troubled assets at auction.

The Act also prohibits any compensation plan that creates incentives for employees to manipulate reported earnings or take unnecessary and excessive risks that threaten the company’s value. The board must also adopt a company-wide policy on luxury expenditures. The Dodd Amendment bans bonuses for many highly-paid executives of TARP-recipient firms under a sliding scale regime based on the amount of financial assistance the TARP recipient received.

The Act defines “senior executive officer” to mean an individual who is one of the top five most highly-paid executives of a public company and whose compensation must be disclosed pursuant to SEC executive compensation rules. Under SEC rules, these are the principal executive officer, the principal financial officer, and the company’s other three most highly-compensated executives.

The Act defines a TARP recipient to mean any entity that has received or will receive financial assistance provided under the TARP. The Act’s restrictions apply during the period when the TARP recipient has outstanding obligations arising from financial assistance provided under TARP. The Act states that the period in which any obligation arising from financial assistance provided under the TARP remains outstanding does not include any period during which the federal government only holds warrants to purchase common stock of the TARP recipient.

Say on Pay

During the period in which any obligation arising from TARP assistance remains outstanding, any proxy or consent or authorization for an annual or other meeting of the shareholders of any TARP company must permit a separate shareholder vote to approve the compensation of executives, as disclosed pursuant to SEC rules (which disclosure must include the compensation discussion and analysis, the compensation tables, and any related material). Within one year of enactment, the SEC must issue final rules and regulations required by this section. The shareholder vote will be nonbinding. Moreover, the Act provides that the vote may not be construed as overruling a decision by the company’s board or as creating any additional fiduciary duty of the board. Similarly, the advisory vote cannot be construed to restrict shareholders from making proposals for inclusion in proxy materials related to executive compensation.

Compensation Committee

As a matter of sound governance, the Act requires each TARP company have a compensation committee composed entirely of independent directors. The compensation committee must discuss and evaluate, at least semiannually, the employee compensation plans and their potential risk to the company’s financial health.

In the case of any TARP recipient, the common or preferred stock of which is not registered pursuant to the Securities Exchange Act of 1934, and that has received $25,000,000 or less of TARP assistance, the duties of the compensation committee under must be carried out by the board of directors.

Retroactive Compensation Review

The Act also requires a retroactive review of bonuses, retention awards, and other compensation already paid out by companies that received TARP funds. Under this provision, Treasury must review bonus and retention awards and other compensation paid to executives of TARP recipients to determine whether any payments were inconsistent with the Emergency Economic Stabilization Act or the TARP or otherwise contrary to public interest. If they are, Treasury must negotiate with the recipient and the subject employee for appropriate reimbursement of the compensation or bonuses to the federal government.

Repayment of TARP Funds and Loan Modifications

The Act provides that, after consulting with the appropriate federal banking agency, Treasury must permit a TARP recipient to repay any assistance previously provided under the TARP without regard to whether the financial institution has replaced such funds from any other source or to any waiting period, and when such assistance is repaid, Treasury must liquidate warrants associated with such assistance at the current market price. Treasury is ordered to adopt regulations implementing the repayment program.

The Act also provides that Treasury must not be required to apply these executive compensation restrictions, or to receive warrants or debt instruments, solely in connection with any loan modification under the Emergency Economic Stabilization Act.

Treasury Standards

During the period in which any obligation arising from financial assistance provided under TARP remains outstanding, each TARP recipient will be subject to the corporate governance and executive compensation standards established by Treasury under the Act and the provisions of Internal Revenue Code Section 162(m)(5).

Tracking SEC executive compensation disclosure rules, the five executive officers covered by Section 162(m)(5) are the chief executive officer, the chief financial officer, and the three highest-compensated officers other than the CEO or CFO. For the purpose of determining the three officers, “compensation” is defined as it is in the SEC rules to mean total compensation, whether or not it is includible in the officer’s gross income. However, unlike the SEC rules that determine the highest three officers by reference to total compensation for the last completed fiscal year, the measurement period under 162(m)(5) for purposes of determining the three officers for an applicable taxable year is that taxable year.

For purposes of Section 162(m)(5), including the determination of whether the aggregate amount of assets acquired from an employer exceeds $300 million, two or more persons who are treated as a single employer under Section 414(b) (employees of a controlled group of corporations) and Section 414(c) (employees of partnerships, proprietorships, etc., that are under common control) are treated as a single employer.An applicable employer for purposes of Section 162(m)(5) is not limited to a publicly traded corporation or even to the corporate business form. Thus, an entity, whether or not publicly traded, is an applicable employer if it sells troubled assets pursuant to the Treasury’s program. Also, unlike the general 162(m) calculation of employee remuneration subject to the deductible limit, 162(m)(5) remuneration includes commissions and performance-based compensation.

Under the Act, Treasury must require each TARP recipient to meet detailed, appropriate standards for executive compensation and corporate governance. These standards must include limits on compensation that exclude incentives for senior executive officers to take unnecessary and excessive risks that threaten the value of the company during the period that any obligation arising from TARP assistance is outstanding. The standards must also include a clawback provision for the recovery of any bonus, retention award, or incentive compensation paid to a senior executive officer and any of the next 20 most highly-compensated employees of the TARP company based on statements of earnings, revenues, gains, or other criteria that are later found to be materially inaccurate.

Further, the corporate governance standards must include a prohibition of any golden parachute payment to a senior executive officer or any of the next five most highly-compensated employees during the period that any obligation arising from TARP assistance is outstanding. The Act defines ``golden parachute’’ to mean any payment to a senior executive officer for departure from a company for any reason, except for payments for services performed or benefits accrued.

There must also be a prohibition of any compensation plan that would encourage manipulation of the reported earnings of a TARP recipient to enhance the compensation of any of its employees.
The Act also requires TARP recipients to establish a compensation committee of the board of directors composed entirely of independent directors for the purpose of reviewing compensation plans. The Act directs the compensation committee of each TARP recipient to meet at least semiannually to discuss and evaluate employee compensation plans in light of an assessment of any risk posed to the TARP recipient from such plans.

Another required corporate governance standard for TARP recipients is that they are prohibited from paying or accruing any bonus, retention award, or incentive compensation during the period in which any obligation arising from financial assistance provided under the TARP remains outstanding, except that any such prohibition must not apply to the payment of long-term restricted stock by such TARP recipient, provided that such long term restricted stock does not fully vest during the period in which any obligation arising from financial assistance provided to the TARP recipient remains outstanding and has a value that is not greater than one-third of the total amount of annual compensation of the employee receiving the stock; and also is subject to any other conditions Treasury may impose in the public interest.

The prohibition on the paying of bonuses by TARP companies will apply in the following way:

For financial institutions that received TARP financial assistance of $25,000,000, or less the prohibition will apply only to the most highly compensated employee of the financial institution.

For financial institutions that received TARP financial assistance of between $25,000,000 and $250,000,000 the prohibition on bonuses must apply to the five most highly-compensated employees, or such higher number as determined by Treasury as being in the public interest.

For financial institutions that received TARP assistance of between $250,000,000 and $500,000,000 the prohibition on bonuses must apply to the senior executive officers and at least the next ten most highly compensated employees or a higher number determined by Treasury as in the public interest.

For any financial institution receiving TARP assistance of $500,000,000 or more the bonus prohibition will apply to the senior executive officers and at least the 20 next most highly compensated employees or such higher number as Treasury may determine as in the public interest.

But the Act also provides that the bonus prohibitions will not be applied to prohibit any bonus payment required to be paid pursuant to a written employment contract entered into on or before February 11, 2009 as such valid employment contracts are determined by Treasury.

The TARP company CEO and CFO must provide a written certification of compliance by the company with the executive compensation and corporate governance requirements. In the case of a TARP company whose securities are publicly traded, the certification must be provided to the SEC, together with annual filings required under the securities laws. For nonpublic companies, the certification must be filed with the Treasury.

Luxury Expenditures

The board of directors of any TARP recipient must implement a company-wide policy regarding excessive or luxury expenditures, as identified by Treasury. These may include excessive expenditures on:

Entertainment or events;
Office and facility renovations;
Aviation or other transportation services; or
Other activities or events that are not reasonable expenditures for conferences, staff development, reasonable performance incentives, or other similar measures conducted in the normal course of business operations.