Monitoring Compliance with Executive Compensation Limits Under the Emergency Economic Stabilization Act
By: Raymond P. Pepe
On January 16, 2009, the U.S. Treasury Department modified the interim final rules regarding executive compensation, originally adopted on October 20, 2008, to establish additional recordkeeping and reporting requirements, and issued a revised version of the executive compensation guidelines applicable to financial institutions participating in programs for Systemically Significant Failing Institutions, which adopt similar requirements. The Treasury acted in response to the Government Accountability Office’s December 2, 2008 report Troubled Asset Relief Program: Additional Actions Needed to Better Ensure Integrity, Accountability and Transparency, which called for the adoption of additional measures to monitor compliance with the executive compensation limits established by the Emergency Economic Stabilization Act.
The executive compensation limitations in the Emergency Economic Stabilization Act apply to a financial institution’s chief executive officer and chief financial officer, plus the next three most highly compensated executive officers. These limitations, which originally applied only to institutions from which non-auction sales of distressed assets were made, now also apply to institutions receiving capital under the Treasury’s Capital Purchase Program. The compensation limits require that the compensation committees of participating financial institutions (1) conduct reviews of compensation arrangements to ensure that they do not encourage unnecessary and excessive risks that threaten the value of the financial institution; (2) mandate the clawback of any bonus or incentive compensation paid based on statements of earnings, gains, or other criteria that are later proven to be materially inaccurate; and (3) prohibit excessive golden parachute payments. The limits also make compensation payments in excess of $500,000 non-deductible for federal income tax purposes.
The January 16, 2009 rules make the following modifications to the October 20, 2008 interim final rules:
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Financial reports and registration statements of financial institutions whose securities are registered with the SEC must include in their compensation committee reports a certification of compliance with the limitations. In contrast, the October interim final rules required the compensation discussion and analysis in an issuer’s annual report to certify compliance without directly linking compliance certification to the activities of corporate compensation committees.
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The clawback provisions have been expanded to apply not only to compensation paid during the time the Treasury holds a debt or equity position in a financial institution, but also to any incentive compensation to which a senior executive officer obtains a legally binding right to payment during the Treasury holding period.
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Within 120 days of the closing date of an agreement between a financial institution and the Treasury under the Capital Purchase Program, the principal executive officer of the financial institution is required to certify to the chief compliance officer of the TARP that the firm’s compensation committee within 90 days after the closing date reviewed the incentive compensation arrangements of senior executive officers with the senior risk officers of the institution to ensure that the compensation arrangements do not encourage unnecessary or excessive risks that threaten the value of the institution.
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Within 135 days of completion of the first year in which an institution participates in the Capital Purchase Program, and each year thereafter during which the Treasury holds a debt or equity position in the institution, the principal executive officer must identify the institution’s senior executive officers subject to compensation limits and provide a certification to the chief compliance officer of the TARP that:
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the compensation committee has met at least once during the most recently ended fiscal year and reviewed the risk management policies and practices of the institution and its senior executive compensation arrangements with the senior risk officers of the institution to ensure that the compensation arrangements do not encourage unnecessary or excessive risks that threaten the value of the institution;
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any payments based upon materially inaccurate financial statements or performance metrics have been recovered;
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excessive golden parachute payments have been prohibited; and
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controls and procedures have been instituted to limit deductions for compensation on federal income taxes to $500,000 for each senior executive officer.
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Records must be kept such that documentation sufficient to substantiate each certification is retained for not less than six years after each certification has been made; maintained in “an easily accessible location” for at least the first two years; and provided to the chief compliance officer of the TARP upon request.
In addition to these modifications to the Treasury rules, Treasury Secretary Timothy Geithner indicated in response to written questions posed by Senator John Kerry that plans are being developed to further require any compensation above a designated limit be paid in the form of restricted stock or another equivalent form of payment that cannot be liquidated or sold until government assistance has been repaid.
