Practitioners' Forum Discussion: New Executive Compensation Restrictions in the Stimulus Bill

By Stuart M. Lewis, Catherine Creech, Keith A. Mong, William F. Sweetnam, Jr., and Norma Sharara

The following is a transcript of an informal discussion of employee benefit practitioners held in Washington, D.C., on February 19, 2009. The topic involved the new executive compensation restrictions in the American Recovery and Reinvestment Act of 2009 (a/k/a the “Stimulus Bill”), P.L. 111-5, which was signed into law by President Obama on February 17, 2009.

Discussion Participants

Stuart M. Lewis, Buchanan Ingersoll & Rooney P.C.

Catherine Creech,Ernst & Young LLP

Keith A. Mong, Buchanan Ingersoll & Rooney P.C.

William F. Sweetnam, Jr., Groom Law Group, Chartered

Norma Sharara, Luse Gorman Pomerenk & Schick, P.C.

Mr. Mong: The President signed the Stimulus Bill on Tuesday [February 17, 2009], which includes new executive compensation and corporate governance rules for companies participating in the Treasury's TARP program. This essentially represents the third round of executive compensation restrictions targeted at TARP companies. The first round included the restrictions imposed in connection with EESA [the Emergency Economic Stabilization Act of 2008] in October 2008. The second round involved the revised executive compensation standards announced by the Treasury on January 16th [2009]. This third round of restrictions under the Stimulus Bill includes, for the first time, a limitation on the type of compensation that can be paid - the new rules generally provide that a TARP company cannot pay or accrue any bonus, incentive or retention compensation while the company is in the TARP program other than in the form of restricted stock that meets certain conditions, including that it cannot vest until the company exits the TARP program.

Ms. Sharara: It should be emphasized, however, that the new rules do not impose a limit on the amount of base compensation that can be paid. The new rules do extend the $500,000 deduction limit under Code §162(m)(5) to all companies participating in TARP [and not just those selling more than $300 million in assets under TARP], but TARP companies remain free to pay whatever base compensation that is otherwise appropriate - some just may now be nondeductible. In response to these new rules, companies may consider restructuring their compensation packages to provide more of the total compensation in the form of base compensation, to replace some of the bonus or incentive compensation that can now only be provided in the form of restricted stock. These new rules should also be contrasted with the revised standards announced by the Treasury in January [2009], which generally included a $500,000 cap on the total cash compensation that could be paid. Any compensation in excess of the $500,000 cash limit would have had to be provided in the form of restricted stock that could also not vest until the company exited the TARP program.

Mr. Lewis: However, the new restrictions under the Stimulus Bill do limit the amount of restricted stock that can be provided. The restricted stock cannot be more than one-third of the executive's annual compensation. In addition, the new limitations on bonus and incentive compensation do not apply to bonus payments paid under employment contracts executed before February 12th [2009]. This could except a lot of bonuses and incentive compensation from the new rules. However, it is not clear how this grandfather rule will ultimately work. For example, if an employment agreement has an annual evergreen provision, it is not clear how long any payments made under that agreement will continue to be excepted.

Ms. Creech: At this point, it is also not completely clear how all of these rules fit together. For instance, the new rules under the Stimulus Bill replace the statutory language under EESA, which authorized a number of the executive compensation standards issued by the IRS and Treasury in October [2008]. However, some of those restrictions were included in new Code §§162(m)(5) and 280G(e), and therefore, those appear to still be applicable. It also appears that the revised standards announced by the Treasury in January [2009] have essentially been superseded by the new rules in the Stimulus Bill. The revised standards were only announced and were not expected to become effective until the Treasury issued additional guidance. I guess we will have to wait and see if the Treasury tries to resurrect in future guidance any of the revised standards [announced in January 2009] that were not included in the Stimulus Bill.

Ms. Sharara: The effective date of the new rules [under the Stimulus Bill] is also not clear. As you noted, the Stimulus Bill replaced the standards provided in EESA with the new executive compensation restrictions. The Stimulus Bill does not include any specific effective date language with respect to this replacement. Thus, one interpretation is that the new rules are retroactively effective - as if originally included in EESA. In this regard, the new language defines the term “TARP recipient” as any entity that has received or will receive financial assistance under TARP - possibly suggesting a retroactive effective date for at least some of the new rules. However, certain sections of the new rules under the Stimulus Bill provide that the Secretary of the Treasury shall establish standards which shall include certain specific standards, including the limitations on bonus and incentive compensation. Thus, there is a strong argument that those new rules do not become effective until the Treasury actually issues guidance.

Ms. Creech: The new rules also prohibit golden parachute payments to the top 10 executives. This new limit, unlike some of the limitations in the prior standards, applies to the first dollar of golden parachute payments. In certain situations, the prior standards only applied the limit to amounts in excess of either one-times or three-times annual compensation.

Mr. Lewis: The new rules also define golden parachute payments broadly to include any payment for leaving a company for any reason. In contrast, Code §280G(e) [which was added by EESA] is limited to payments in connection with involuntary terminations, bankruptcies and other liquidations.

Mr. Mong: How are your clients reacting to these new rules?

Ms. Sharara: I work mostly with small to mid-size financial institutions and not for large, national banks that you tend to see in the headlines nowadays. In most cases, these smaller institutions are in relatively good financial condition and do not need the TARP money to survive. Rather, in many cases, they applied for the TARP money to provide a cushion for possible further declines in their balance sheets and to provide a funding source for possible acquisitions of other banks that may be attractive in the current environment. Because of these new rules, many of these banks are considering returning the TARP money to avoid having to implement the restrictions. They feel that they may not be able to retain and attract the executives necessary to run a successful financial institution if these new restrictions apply to their executives solely because they have TARP money.

Mr Sweetnam: It is my understanding that a number of people on the Hill believe that, in most cases, attracting and retaining experienced and talented executives to run these institutions would not be that difficult, particularly in the current economic environment. For that reason, they did not feel that these new rules would significantly impair a company's ability to find and retain executives. If your experience is different from their understanding, you may want to communicate that to those on the Hill. I think that is an important message, particularly the fact that some of the financial institutions are considering returning the TARP funds just to avoid the new rules.

Ms. Creech: The new rules also include a provision that requires the Treasury to review bonuses and other compensation that has already been paid to the top 25 executives of the companies that have received TARP funds. If the Treasury concludes that the compensation was inconsistent with the purposes of TARP or otherwise contrary to the public interest, they are supposed to negotiate with the company and the executive in an effort to obtain a reimbursement of the excess compensation.

Mr. Sweetnam: The new rules do not include any specific sanctions or penalties that the Treasury can impose or other incentives the Treasury can use in these negotiations other than the statutory directive to pursue those amounts. In addition, it is not clear that the Treasury has the resources to review the compensation of all of the targeted executives, and even if they could, it is not clear what the proper standards would be for determining whether the compensation was excessive, particularly given the levels of compensation commonly paid before the financial crisis came about. Under these conditions, it is certainly not clear how this provision can be implemented effectively.

This commentary also will appear in the May 2009 issue of the Tax Management Compensation Planning Journal. For more information, in the Tax Management Portfolios, see Moran, 390 T.M., Reasonable Compensation, and in Tax Practice Series, see ¶5420, Reasonable Compensation.