Financial Reform Watch

Buried in the American Recovery and Reinvestment Act (ARRA), which is making its final march through Congress on its way to the president’s desk, is a section imposing limits on executive compensation for Troubled Asset Relief Program (TARP) recipients. The White House and the Treasury Department announced new executive compensation restrictions last week, but Congressional leadership obviously believed there was a need to codify some of those rules and strengthen others.

Here is an overview of the legislative provisions that, when enacted, will apply to companies until they repay their TARP money.

Clawback—Whereas the Treasury policy was only retroactive for the top five senior executives, the ARRP would allow Treasury to recover the “bonus, retention award, or incentive compensation paid” to the top five senior executives and the next 20 highest compensated employees of all TARP recipients, if any of their pay was based on materially inaccurate “statements of earnings, revenues, gains or other criteria.”

Golden Parachute—Treasury imposed strict limits on TARP “exceptional assistance” recipients and less strict limits on Capital Purchase Program recipients. The ARRP would restrict golden parachutes to all TARP recipients’ top 10 senior executives until the government is repaid.

Bonus Restrictions—Treasury imposed total compensation limits of $500,000 for some senior executives. The AARP does not limit compensation, but it prohibits cash bonuses for several senior executives. The legislation does allow for bonus payments in the form of long-term, restricted stock, but the stock cannot be worth more than one-third of the annual salary of the employee receiving it and cannot vest until the institution settles its TARP debt with Treasury. The number of senior executives affected depends on the amount of TARP money an institution has received, and the Treasury Secretary can also expand the restriction to a larger pool of executives in each of the following categories:

$25 million to $250 million of TARP – applies to top 5 senior executives

$250 million to $500 million of TARP – applies to top 15 senior executives

$500 million or more of TARP – applies to top 25 senior executives

There is an interesting exception clause, however, that states the bonus restrictions “shall not be construed to prohibit any bonus payment required to be paid pursuant to a written employment contract executed on or before February 11, 2009, as such valid employment contracts are determined by the Secretary or the designee of the Secretary.”

Board Compensation Committee—ARRA calls for TARP recipients to each establish a new Board Compensation Committee that is to meet semiannually to evaluate employee compensation plans. The Treasury policy relies on companies’ existing compensation committees.

Limits on Luxury Expenditures—Like the Treasury policy, ARRA requires the Boards of Directors of all TARP recipients to institute a company-wide policy regarding excessive or luxury expenditures, including entertainment, events, office and facility renovations, aviation or other transportation services, and any other activities or events that are not reasonable business expenditures.

Say on Pay—Whereas the Treasury policy requires companies receiving exceptional TARP assistance to disclose executive compensation information to shareholders and allow for a “say on pay” shareholder resolution, the ARRA requires TARP recipients to hold separate, nonbinding shareholder votes to approve the compensation of senior executives.

The ARRA also prohibits the manipulation of earnings reports in order to enhance compensation, and requires CEOs and CFOs of TARP recipients to submit annual certifications of compliance with these new TARP rules to the SEC (if the company is publicly traded) or to the Treasury.