Compliance with TARP Executive Compensation Restrictions Subject to SEC Enforcement
By: Brian A. Ochs
A little-noticed recent amendment to the Emergency Economic Stabilization Act of 2008, 12 U.S.C. §5221 (“EESA”), may provide the Securities and Exchange Commission (“SEC”) with a prominent role in enforcing the executive compensation and corporate governance requirements under the Treasury Department’s Troubled Asset Relief Program (“TARP”). The amendment, which was signed into law on February 17 as part of the American Recovery and Reinvestment Act of 2009 (the “Recovery Act”) (Pub. L. No. 111-5), requires the chief executive officer and chief financial officer (or their equivalents) of any public company that receives TARP funds to certify compliance with EESA’s executive compensation and corporate governance restrictions as part of the company’s annual SEC filing. Much like the required officer certifications regarding internal controls and disclosure controls that have been part of the legal landscape since the enactment of the Sarbanes-Oxley Act of 2002, the effect of the EESA certification requirement is to focus personal responsibility for EESA compliance on CEOs and CFOs, with the potential for securities fraud or other charges to be brought by the SEC in the event of false certifications.
EESA and the Treasury Department’s Interim Rules on Executive Compensation
As originally enacted, section 111(b) of EESA directed that any financial institution that sells troubled assets to the Treasury Department must meet certain standards of executive compensation and corporate governance. These standards included: (1) eliminating incentives for senior executives to take unnecessary and excessive risks that threaten the financial value of the institution; (2) a “clawback” provision for the recovery by the institution of any bonus or incentive compensation paid to a senior executive officer based on financial statements or other criteria that are later proven to be materially inaccurate; and (3) a prohibition on “golden parachute” payments to senior executive officers. (Generally, “senior executives” means the five highest paid officers of the company.)
In October 2008 and January 2009, the Treasury Department announced rules to implement the executive compensation requirements of section 111 for participants in the TARP Capital Purchase Program (“CPP”). (The Treasury Department separately provided guidance for certain other TARP programs.) Among other things, the January rule required the principal executive officer of each participating financial institution to certify to TARP’s Chief Compliance Officer that the institution was in compliance with the executive compensation requirements set forth in EESA. The Treasury Department further noted in the January rule that a false certification could subject the certifier to federal criminal penalties for false statements under 18 U.S.C. §1001. See CPP Executive Compensation Final Rule (Jan. 16, 2009).
The Recovery Act Amendments
The Recovery Act (Section 7001) expanded the significance of these provisions in several important respects. First, it directs the Secretary of the Treasury to impose new and expanded executive compensation and corporate governance standards on all recipients of TARP funds. In addition to the restrictions found in the original section 111, these standards must bar payment of any bonus, retention award, or incentive compensation during the period that a TARP obligation is outstanding (except for payments made in restricted stock comprising no more than one-third of the individual’s total compensation, and not fully vesting during the period that the obligation is outstanding), and must prohibit any compensation plan that would encourage earnings manipulation. The number of employees to which the new compensation limitations apply varies by provision, in many cases going beyond the original five “senior executive officers” to as many as the next 20 most highly compensated officers. In addition, the Recovery Act amendments require SEC registrants that receive TARP funds to establish a board compensation committee, comprised entirely of independent directors, and also require boards of directors to implement company-wide policies regarding excessive or luxury expenditures.
Section 7001 of the Recovery Act also requires the CEO and CFO (or their equivalents) of each recipient of TARP funds that has publicly traded securities to “provide a written certification of compliance by the TARP recipient with the requirements of this section … together with annual filings required under the securities laws….” (Certifications are to be provided to the Secretary of the Treasury if the entity receiving TARP funds is not a publicly traded company.) The SEC has determined that it will not give effect to the certification requirement until the Secretary of the Treasury establishes standards to implement section 7001 of the Recovery Act. This approach follows the views expressed by Senator Christopher Dodd, the author of the executive compensation provisions of the Recovery Act, in a February 20 letter to SEC Chairwoman Mary Schapiro.
Analysis
The requirement that CEO and CFO certifications be filed with a TARP recipient’s annual report to the SEC will unambiguously subject public companies that receive TARP funds and their executives to SEC scrutiny and potential enforcement action for failure to comply with EESA’s executive compensation and corporate governance requirements. This is because any material false statement in an SEC filing may be charged as a securities fraud or other securities violation, depending on the actor’s level of intent. In the current environment, regulators are likely to view a certification that an entity receiving TARP funds is in compliance with requirements concerning executive compensation and corporate governance as being material to investors. In particularly egregious cases, criminal prosecution for securities fraud could also result.
Further, because the CEO and CFO will each be considered the “maker” of statements in the EESA certifications, these executives could be exposed to personal liability under the securities laws for compliance failures that result in false certifications. Since the passage of the Sarbanes-Oxley Act, most companies have instituted formal procedures such as compliance checklists, sub-certifications by managers with line responsibilities, and disclosure committee reviews, to support the CEO and CFO certifications required by that Act. Entities that receive TARP funds will need to consider implementing similar structured processes to support the CEO’s and CFO’s annual certifications under EESA.
