Executive Compensation

by Joseph E. Bachelder

This article is reprinted with permission from the
April 14, 2009
edition of
New York Law Journal.
2009 NLP IP Company.

ARRA Amends EESA: Includes New Pay Limits at Affected Institutions

On Feb. 17, 2009, President Barack Obama signed into law the American Recovery and Reinvestment Act of 2009 (ARRA). Title VII, Section 7001 of ARRA amends Section 111 of the Emergency Economic Stabilization Act of 2008 (EESA) as enacted Oct. 3, 2008. Section 111 contains restrictions on executive compensation applicable to institutions receiving financial assistance under the Troubled Assets Relief Program (TARP).[1] For purposes of this column, Section 111 as amended by ARRA is referred to as "New Section 111," and Section 111 as originally enacted under EESA is referred to as "Original Section 111."

New Section 111 continues certain provisions of Original Section 111 but expands the number of executives covered (with different numbers of executives covered under different provisions), imposes stricter limitations on compensation payments, prohibits severance payments to certain executives and adds new corporate governance standards and requirements relating to those standards.

Generally speaking, the limitations and standards under New Section 111 apply during the period in which any obligation arising from financial assistance provided under the TARP remains outstanding (referred to herein as the "TARP Period"). Under New Section 111 the TARP Period ends even if the government still holds warrants. The statute applies to a "TARP Recipient," defined as "any entity that has received or will receive financial assistance under the financial assistance provided under the TARP."

Further complicating matters are additional compensation guidelines announced by the U.S. Treasury on Feb. 4, 2009, in a press release ("Treasury Announces New Restrictions on Executive Compensation," Press Release No. TG-15, referred to hereinafter as "TG-15").[2] TG-15 applies one set of guidelines to companies receiving "exceptional assistance" and another (albeit with some overlapping of guidelines) for companies receiving assistance under "generally available capital access programs."[3]

Following is a review of selected provisions of New Section 111 including, as applicable, a comparison of it to Original Section 111 and TG-15. (As of the time this column was written, regulations had not yet been issued under New Section 111.)

1. Limitations on Bonus Payments.[4]

(a) Requirements of New Section 111(b)(3)(D).

Under New Section 111(b)(3)(D), a TARP Recipient is prohibited, as to certain employees (identified below), from paying or accruing "any bonus, retention award, or incentive compensation" during the TARP Period, except in the form of long-term restricted stock that "does not fully vest" during the TARP Period and is valued at no more than one-third of the employee's "total amount of annual compensation." The Treasury Secretary is authorized to place other conditions on such restricted stock as deemed "in the public interest."

The bonus prohibition of New Section 111(b)(3)(D) applies to institutions that became TARP Recipients prior to the date of enactment as well as those that become TARP Recipients in the future. The provision does not prohibit "any bonus payment required to be paid pursuant to a written employment contract executed on or before February 11, 2009," provided the Secretary finds the contract to be "valid."

The number of employees to whom the bonus prohibition applies depends on the amount of TARP assistance the company has received. The range, in four categories depending on the amount of assistance, is from "the most highly compensated employee," for a TARP Recipient receiving less than $25 million of assistance to the "senior executive officers" plus "at least" the "20 next most highly-compensated employees" for TARP Recipients receiving $500 million or more in assistance.[5] (See next paragraph for possible increase by the Treasury in the applicable number.)

New Section 111(a)(1) defines a "senior executive officer" (hereinafter, an "SEO") as "an individual who is one of the top five most highly paid executives of a public company, whose compensation is required to be disclosed pursuant to the Securities Exchange Act of 1934, and any regulations issued thereunder, and nonpublic company counterparts." This definition, which is contained in New Section 111(a)(1), is essentially the same definition as that contained in Original Section 111(b)(3). "Most highly-compensated employees," referred to hereinafter as "Most Highly-Compensated Employees," is not defined in New Section 111. For companies receiving $25 million or more in TARP assistance, the Treasury may increase the number of Most Highly-Compensated Employees subject to the limitation if deemed by the Treasury "to be in the public interest."

(b) Comparison of New Section 111(b)(3)(D) to Original Section 111.

There is no counterpart to New Section 111(b)(3)(D) in Original Section 111.

(c) Comparison to TG-15.

In the case of certain TARP Recipients, TG-15 contains a $500,000 cap on annual compensation paid to "senior executives." The term "senior executives," as used here, apparently has the same meaning as "senior executive officers" in New Section 111(a)(1), discussed above.

Thus, while TG-15 does not contain a bonus limitation corresponding to New Section 111(b)(3)(D), the effect of the $500,000 cap on annual compensation for a "senior executive" affected by this limitation who has a salary of $500,000 or more could be to prevent any bonus to such "senior executive," subject to the exception noted in the next sentence. TG-15 allows an exception from the $500,000 "total amount of compensation" limitation for payments made in restricted stock or "similar long-term incentive arrangements" provided they do not pay out until after the end of a period corresponding with the TARP Period (or such other period as the Treasury determines).

The $500,000 compensation cap in TG-15 applies to TARP Recipients receiving "exceptional assistance"; it also applies to TARP Recipients under "generally available capital access programs" if they fail to comply with certain requirements under TG-15.[6] Because TG-15 subjects only five "senior executives" to this limitation and is prospective only, the number of executives to which this cap under TG-15 will apply should be quite limited.

2. Prohibitions on Severance Pay.

(a) Requirements of New Section 111(b)(3)(C).

Under New Section 111(b)(3)(C), TARP Recipients are prohibited from making any "golden parachute payment" (meaning any severance payment, as noted below) to SEOs and the next five Most Highly-Compensated Employees during the TARP Period.[7] New Section 111(b)(3)(C) prohibits only the payment itself and does not appear to prohibit a TARP Recipient from entering into an agreement during the TARP Period to pay severance at some point in the future when the TARP Period ends.

The term "golden parachute payment" is used to describe any payment to an SEO in consequence of a "departure from a company for any reason, except for payments for services performed or benefits accrued." The statute does not clarify what payments are subject to the exception clause. A salary payment earned and due presumably is covered by the exception. However, there are many different kinds of post-termination payments as to which the applicability of this exception is unclear.

(b) Comparison of the New Section 111(b)(3)(C) to the Original Section 111(b)(2)(C).

New Section 111(b)(3)(C) differs from corresponding provisions in Original Section 111(b)(2)(C) in several respects: it applies to 10 top executives rather than to five; it prohibits any severance payment rather than limiting the prohibition to amounts equal to or in excess of three times the employee's "base amount" (the three-times multiple being provided in the regulations at 31 CFR Part 30, §30.9). On the other hand, New Section 111(b)(3)(C) excepts from severance payment status, as noted above, payment "for services performed or benefits accrued," an exception not made in Original Section 111.

(c) Comparison to TG-15.

TG-15 provides that "the top ten senior executives" at companies receiving "exceptional assistance" may not receive "any golden parachute payment upon severance from employment," and "the next twenty-five executives" may not receive "any golden parachute payment greater than one year's compensation upon severance from employment."[8] In addition, the "top five senior executives" at companies participating in "generally available capital access programs" (as opposed to "exceptional assistance" programs) may not receive "a golden parachute payment greater than one year's compensation."[9]

3. Corporate Governance Standards.

(a) Incentives that encourage unnecessary risks.

(i) Requirements of New Section 111(b)(3)(A).

New Section 111(b)(3)(A) provides that the standards established by the Treasury under New Section 111 must exclude incentives that encourage SEOs to take unnecessary and excessive risks that threaten the value of such TARP Recipient during the TARP Period.

(ii) Comparison of New Section 111(b)(3)(A) to Original Section 111(b)(2)(A).

The substance of this provision is essentially unchanged from its original version although different terminology is used to describe the period to which the TARP restrictions apply (the "TARP Period" as used in this column).[10]

(iii) Comparison to TG-15.

TG-15 requires that companies participating in a "generally available capital access program" must explain why compensation arrangements do not encourage excessive and unnecessary risk-taking. In the case of companies under an "exceptional assistance" program, explanation that compensation is tied to sound risk management "must be submitted to non-binding shareholder resolution."

(b) Clawback of Improperly Determined Pay.

(i) Requirements of New Section 111(b)(3)(B).

New Section 111(b)(3)(B) provides that the Treasury shall establish standards requiring a TARP Recipient to recover any bonus, retention award or incentive compensation paid to an SEO or to any of the next 20 Most Highly-Compensated Employees that is "based on statements of earnings, revenues, gains, or other criteria that are later found to be materially inaccurate."

(ii) Comparison of New Section 111(b)(3)(B) to Original Section 111(b)(2)(B).

New Section 111(b)(3)(B) applies to the SEOs plus the next 20 Most Highly-Compensated Employees instead of only the SEOs or their equivalents under the Original Section 111(b)(2)(B). It also explicitly applies to any "retention award" as well as any "bonus" or "incentive compensation" and it adds statements of revenues to the list of criteria which, if found inaccurate, may trigger clawback.

(iii) Comparison to TG-15.

TG-15 also contains a clawback provision, which applies to the "top five senior executives." TG-15 extends the covered executive group to include "the next twenty senior executives if they are found to have knowingly engaged in providing inaccurate information relating to financial statements or performance metrics used to calculate their own incentive pay." Thus, TG-15 differs from New Section 111(b)(3)(B) because the second level of executives, that is, the next 20 executives covered under TG-15, are exempted if they did not "knowingly" engage in providing financial misstatements covered by TG-15.

(c) Prohibition of plans that encourage manipulation of earnings.

(i) Requirements of New Section 111(b)(3)(E).

New Section 111(b)(3)(E) prohibits any compensation plan that encourages manipulation of reported earnings to enhance compensation. (See discussion below regarding issues that may relate to statutory retroactivity.)

(ii) Comparison to Original Section 111. Original Section 111 contains no direct counterpart to this provision.[11]

(iii) Comparison to TG-15. TG-15 contains no direct counterpart to this provision.[12]

4. Other Provisions of New Section 111.

(a) Payments Inconsistent with TARP: Negotiated Reimbursement (New Section 111(f)).

Under this new section, the Treasury is required to review bonuses, retention awards and other types of compensation which, prior to the date of enactment of New Section 111, were paid to SEOs and the next 20 Most Highly-Compensated Employees. If such compensation is found to be inconsistent with the purposes of TARP, "the Secretary shall seek to negotiate with the TARP Recipient and the subject employee for appropriate reimbursements to the Federal Government." Neither Original Section 111 nor TG-15 contains a provision comparable to New Section 111(f).

(b) Certification of compliance.

New Section 111(b)(4) requires that the CEO and CFO (or holders of equivalent positions) of each TARP Recipient provide written certification that the company has complied with New Section 111.[13] Original Section 111 does not contain a provision comparable to New Section 111(b)(4).[14] TG-15, on the other hand, requires chief executive officers of covered companies to certify compliance with various restrictions on executive pay.

(c) Miscellaneous.

Under New Section 111:

(i) a Board Compensation Committee (or, in the case of certain TARP Recipients, the Board itself), comprised of independent directors, must meet at least semiannually to review and evaluate compensation plans from a risk standpoint (New Section 111(c));

(ii) a company-wide policy regarding excessive or luxury expenditures must be in place (New Section 111(d)); and

(iii) an annual nonbinding say-on-pay vote during the TARP Period must be permitted (New Section 111(e)).

TG-15 has requirements to similar effect as to each of these three areas. Original Section 111 did not contain such provisions.

5. Retroactivity of New Section 111.

New Section 111 may nullify preexisting bonus, retention and other incentive arrangements except where pursuant to a valid "written employment contract" entered into on or before Feb. 11, 2009. It also may nullify preexisting agreements to pay severance (there is no exception like that just noted for bonus or similar payments).

Employees who are denied compensation or severance previously agreed to may assert that their rights under the Fifth Amendment have been violated.[15] It is doubtful that waivers previously signed by top officers at existing TARP Recipients would apply beyond the requirements of Original Section 111. And many of the additional employees to whom New Section 111 applies will not have signed waivers.


[1] Title VII of ARRA (in Section 111(b)(1)(B)) also contains a tax deduction limitation incorporating provisions of Internal Revenue Code Section 162(m)(5), added by EESA Section 302(a), as explained below in footnote 4. (Section 302 of EESA amended the Internal Revenue Code to provide new tax rules applicable to certain executives at certain TARP-covered institutions.) Section 111 and Section 302, as introduced by EESA, were discussed previously in this column. See Joseph E. Bachelder, "Executive Pay at Affected Institutions," New York Law Journal, Nov. 14, 2008, at p. 3.

[2] TG-15 was released approximately two weeks before the enactment of ARRA. There has been no official suggestion by the Treasury that TG-15 will be modified or revoked in view of the enactment of ARRA.

[3] TG-15 describes "exceptional assistance" as follows: "If a firm needs more assistance than is allowed under a widely available standard program, then that is exceptional assistance."

AIG, Bank of America and Citi are cited in TG-15 as examples of firms that had already needed exceptional assistance. "Generally available capital access programs," on the other hand, are programs with uniform terms for all recipients, limits on the amount that each institution may receive, and specified returns for taxpayers, according to TG-15.

[4] In addition to the limitations on bonus or similar payments described in this column, New Section 111(b)(1)(B), as noted in footnote 1, also provides a tax deduction limitation. This limitation applies to certain compensation ("executive remuneration") in excess of $500,000. It does this by incorporating, "as applicable," provisions of new section 162(m)(5) of the Internal Revenue Code (added by EESA Section 302(a)).

[5] Besides the two categories noted in the text, there are two intervening categories of TARP Recipients as follows:

For companies that have received at least $25 million but less than $250 million, the covered employees are "at least the 5 most highly-compensated employees." For companies that have received at least $250 million but less than $500 million, the covered employees are "the senior executive officers" and "at least the 10 next most highly-compensated employees." ("Senior executive officers" are defined in the paragraph of the column immediately following reference to this footnote (and thereafter are referred to as "SEOs").)

[6] See footnote 3 above for discussion of the meaning of "exceptional assistance." A TARP Recipient that is subject to TG-15 because of its participation in a "generally available capital access program" would subject its "senior executives" to the $500,000 salary cap only if it failed to disclose compensation as required by TG-15 and, "if requested," failed to allow a non-binding say-on-pay shareholder vote.

[7] See discussion in the text at Paragraph 5 of the column, "Retroactivity of New Section 111," as to a constitutional issue that appears to be involved if the Government takes the position that New Section 111(b)(3)(C) nullifies pre-existing arrangements for severance pay.

[8] Although not explicitly defined, the context of TG-15's references to "golden parachute payments" suggests that the term means any severance payments, not just payments that in the aggregate are equal to or in excess of three times the executive's "base amount" under Original Section 111(b)(2)(C)). See 31 CFR Part 30, §30.9.

[9] The term "top five senior executives" as used in TG-15 appears to mean the top five senior executives for SEC proxy reporting purposes. But when the term "senior executives" is used in TG-15 in reference to larger groups of employees (e.g., "the top ten senior executives" or "the next 25 senior executives"), it is not clear what is meant. Presumably, the primary consideration will be compensation but what is meant by "compensation" and whether other factors are taken into account is not clear.

[10]. Original Section 111(b)(2)(A) was applicable for the period "that the Secretary holds an equity or debt position in the financial institution." For discussion of the comparable period under New Section 111(b)(3)(A), see the second paragraph of the column.

[11] But see discussion in Paragraph 3(b)(ii) above under the heading "Clawback of Improperly Determined Pay."

[12] But see discussion in Paragraph 3(b)(iii) above under the heading "Clawback of Improperly Determined Pay."

[13] CEOs and CFOs (or equivalents) of publicly traded companies are to provide the certification to the SEC, while CEOs and CFOs (or equivalents) at non-public companies are to provide the certification to the Treasury Secretary.

[14] Original Section 111 does not contain a certification provision in its text, but the regulations issued thereunder provide for compensation committees to certify that they have reviewed "the SEO incentive compensation arrangements to ensure that the incentive compensation arrangements do not encourage SEOs to take unnecessary and excessive risks." 31 CFR Part 30, §30.10.

[15] The last part of the Fifth Amendment provides that no person shall "be deprived of life, liberty, or property, without due process of law; nor shall private property be taken for public use, without just compensation."