• The administration's proposed guidelines would cap senior executive compensation for recipients of "exceptional assistance" at $500,000 plus long-term restricted stock, and would similarly cap senior executive compensation for senior executives of recipients of "generally-available" TARP programs at $500,000 plus restricted stock, but the latter cap would be waivable if certain requirements are satisfied. The Recovery Act would not prohibit caps on total compensation. However, the administration's guidelines do not limit the amount of restricted stock that could be granted, while the Recovery Act does.
  
  

• Unlike the direct prohibition on incentive compensation described above, the Secretary's review is not limited to incentive compensation.
  
  
• The applicable standard—"inconsistent with the purposes" of the Recovery Act or the TARP or "otherwise contrary to the public interest"—is very broad.
  
  
• The requirement to "seek to negotiate" appears to acknowledge that retroactive enforcement of the rules could be problematic; however, this creates potential for jawboning companies or employees to reimburse compensation the Secretary disapproves of.
  
  
• Any reimbursed compensation will be paid to the Government, not the TARP recipient which paid it in the first place.

Unresolved Questions and Comments

• What entity is the "TARP recipient" for purposes of determining which employees are covered? Is it the actual entity that receives the assistance (e.g., the parent holding company, in the case of an equity investment) or does the term cover other entities within a controlled group?
  
  
  
  
  • The Treasury's guidelines for Capital Purchase Program (CPP) investments applied to a controlled group (as defined by reference to certain provisions of the Internal Revenue Code). However, as a general proposition, the Treasury guidelines only applied to SEOs. Will the Treasury apply the same principle to determine which "highly-compensated employees" besides SEOs are covered?
    
    
• How will "most highly-compensated employees" be determined? What types of compensation will be included, and, if forms of compensation other than cash salary and bonuses are included, how will they be valued? What will be the measurement period? The Act does not say as of what point the highly-compensated employees will be determined or whether there will be re-evaluations periodically after the first calculation.
  
  

Other Compensation Restrictions

Executive Compensation Standards

Standard	Persons Covered	Comments
Limitation on compensation to exclude incentives to take "unnecessary and excessive risks"	SEOs	No substantive change from Stabilization Act
Clawback of bonus, retention award or incentive compensation based on "statements of earnings, revenues, gains or other criteria" later found to be materially inaccurate	SEOs and 20 next most highly compensated employees	Stabilization Act only covered SEOs Substantively similar to Stabilization Act, though new language adds the terms "retention award" and "revenue" in the relevant clauses The administration also advanced a clawback rule, though its guidance applies to "next twenty senior executives" (as opposed to employees) and only applies to their knowingly providing inaccurate information to calculate their own pay
Prohibition on payment of "golden parachutes," defined basically to mean no severance upon departure for any reason	SEOs and next five most highly compensated employees	Prior golden parachute rules applied only to SEOs Current Treasury rules for CPP permit payment of up to three years base compensation and only apply to involuntary termination or termination in connection with bank failure or insolvency. Stricter rules apply to SEOs of systemically significant failing financial institutions Administration's proposed guidelines differ in certain respects: recipients of exceptional assistance—top five plus next 10 get no severance and next 25 limited to one year; and other recipients—top five limited to one year
Prohibition on any compensation plan that would "encourage manipulation of the reported earnings of such TARP recipient to enhance the compensation of any of its employees"	N/A	This is a new provision, though a comparable provision was included in the auto industry assistance bill that was not passed

• Application to Existing TARP Recipients. Notably, unlike the incentive compensation provisions, these more general compensation provisions do not contain any grandfather provisions. Existing participants in the CPP were required to secure agreements by SEOs to the standards adopted by the Treasury in October 2008. The new clawback and golden parachute standards go beyond those required by the existing agreements and cover persons who were not subject to such agreements.
  
  

  • Luxury Expenditures

    The Board of each TARP recipient will be required to have in place a company-wide policy regarding "excessive or luxury" expenditures. The covered expenditures will be identified by the Secretary and may include entertainment or events; office and facility renovations; aviation or other transportation services; or other activities or events "that are not reasonable expenditures for staff development, reasonable performance incentives, or other similar measures conducted in the normal course of the business operations of the TARP recipient."

    • This largely enacts into law the administration's proposed guidance on luxury expenditures.
      
      
    • Applying the distinction between "excessive or luxury" expenditures and permitted "reasonable," ordinary-course expenditures may pose interesting challenges for the regulators.

    Compliance Certification

    The CEO and CFO of each TARP recipient will be required to provide a written certification of compliance by the TARP recipient with the executive compensation and governance requirements of the Recovery Act. Publicly-traded TARP recipients will provide the certification to the Securities and Exchange Commission (SEC), apparently in their annual filings under the securities laws. Non-publicly-traded TARP recipients will provide the certification to the Secretary.

    • The current Treasury guidelines for the CPP, as well as the administration's proposed executive compensation guidance, already contain certification requirements. This provision generally codifies the certification requirement and presumably will be fleshed out by the new regulations.
      

    Governance Requirements

    Compensation Committee

    Each TARP recipient is required to have a Board Compensation Committee (Committee), comprised entirely of independent directors, for the purpose of reviewing employee compensation plans. The Committee is required 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." For non-public companies that have received less than $25 million of TARP assistance, the Committee's duties can be carried out by the board of directors (which presumably need not be independent).

    • Most public companies have compensation committees composed of independent directors pursuant to SEC and stock exchange rules. The current Treasury guidelines already require the compensation committee of CPP recipients to assess and report on whether the recipient's compensation plans excluded incentives for unnecessary and excessive risks. These committees presumably will be able to incorporate the Recovery Act's new duties into their existing processes.
      
      
    • This requirement may create difficulties for non-public companies. These companies may not have independent directors who can comprise a compensation committee. It may be difficult for them to attract independent directors.

    "Say-on-Pay"

    The Recovery Act generally requires that each TARP recipient permit a shareholder vote to approve the compensation of executives as disclosed under the SEC's compensation disclosure rules. While the language is not entirely clear on this point, the Recovery Act appears to contemplate an annual vote in conjunction with the proxy statement containing the compensation disclosures required by the SEC. The vote would be non-binding on the board of directors, and the Recovery Act states that the vote will not be construed "as overruling a decision by such board, nor to create or imply any additional fiduciary duty by such board." The required vote will also not restrict or limit the ability of shareholders to make shareholder proposals related to executive compensation for inclusion in the recipient's proxy statement. The SEC is directed to issue rules implementing this subsection within one year of enactment.

    • Under current SEC rules, compensation information is required to be disclosed for the top five SEOs. It is unclear whether this provision will require disclosure about a larger group of executives or employees.
      
      
    • There may be questions about whether TARP recipients must include a say-on-pay item in proxies for upcoming 2009 annual meetings and, if so, what the disclosure rules will be with respect to them.
      
      
    • This appears to override the administration's proposed guidelines, which would require a shareholder vote on executive compensation only by participants in generally available capital access programs and then only when they wished to waive the limitations on compensation payable to SEOs to $500,000 plus restricted stock.

    Withdrawal from TARP

    Under the existing terms of the CPP, a TARP recipient may redeem preferred stock issued to the government only from the proceeds of certain equity offerings and within three years of the issuance. The Recovery Act contains a new provision that permits TARP recipients to withdraw from the program at any time by repaying the amount of the assistance, without regard to the restrictions on redemption. This provision apparently was included to accommodate recipients who do not wish to continue to be subject to the executive compensation or other provisions of TARP.

    Under the new provision, the Secretary is required to permit a TARP recipient to repay any assistance "without regard to whether the financial institution has replaced such funds from any other source or to any waiting period." When such assistance is repaid, the Secretary is also required to "liquidate warrants associated with such assistance at the current market price." The TARP recipient's right to withdraw from the program is subject to consultation with the appropriate federal banking agency, but the agency does not have the power to prohibit the recipient from withdrawing.

    Income Tax

    The Recovery Act does not change the Stabilization Act's rules regarding deductibility of executive compensation paid by TARP recipients. Under the Stabilization Act, the provisions of section 162(m)(5) of the Internal Revenue Code only apply to TARP recipients from which Treasury purchases troubled assets through auction. However, the Treasury has made application of section 162(m)(5) an explicit condition of participation in all TARP programs to date. Section 162(m)(5), as applied, is limited to a group of five covered executives defined similarly to SEOs.

    ¹ The executive compensation provisions are contained in Section 7001 of the Recovery Act. This section amends Section 111 of the Stabilization Act, which contained that Act's executive compensation and governance provisions, in its entirety and replaces it with the new provisions. Among other things, the new section eliminates the distinctions in the applicable rules in the former section based on the type of TARP assistance provided.

    ² The Recovery Act uses essentially the same definition as the Stabilization Act. It refers to the top five most highly-compensated executives of public companies whose compensation is required to be disclosed by SEC rules and "non-public counterparts." The Treasury's rules implemented this definition, including designating the CEO and CFO as among the top five SEOs.