Treasury Issues New Executive Compensation Rules for TARP
Recipients; Proposes Guidelines for Future Legislation
By Michael G. Kushner,
Esq.
Curtis, Mallet-Prevost, Colt & Mosle LLP, New York, NY
The IRS has issued Interim Final
Regulations1 on the
executive compensation provisions of the Emergency Economic
Stabilization Act of 2008
(“EESA”),2 and the
American Recovery and Reinvestment Act of 2009
(“ARRA”),3 generally
effective June 15, 2009. The rules implement an increasingly
restrictive executive compensation regime for financial institutions
that received government funds under the federal TARP program but have
not yet repaid them to the government. Original speculation that the
Treasury would set a hard cap on annual compensation for top
executives of such entities, such as $500,000, however, proved to be
unfounded. The regulations establish what has been called a “pay
czar” to help enforce the provisions of the law and Treasury
further has announced its intention to seek legislation that would
apply similar restrictions to all publicly traded companies.
The CEO and CFO of an entity that holds TARP funds must certify
compliance with these executive compensation rules to the Treasury
and, in the case of a publicly traded company, the SEC or, in the case
of a nonpublicly traded company, to its primary regulator. The
regulations refer to the period during which an institution holds
un-repaid TARP funds as the “TARP period.” While these
restrictions impose reasonable limitations designed to make certain
that TARP funds are used for their intended purpose; to assure
adequate capitalization of financial institutions and to free up
frozen credit markets, the Treasury's push for legislation to extend
similar provisions to non-TARP recipients and to all other publicly
traded companies, is of greater concern, as it could impose
significant retention and compliance burdens on companies that have
been operating within the law. The key points of the Interim Final
Regulations are as follows.
1. Covered Executives. The rules generally apply to senior
executive officers (“SEOs”) and the other top five
officers of a recipient that is a public company whose compensation
must be disclosed on the company's proxy statement under SEC
rules.
2. Bonuses. Senior executives of a recipient cannot receive
or accrue any bonus, retention award or incentive compensation. This
rule can cover up to 25 of a company's executives depending on how
much it received in TARP funds. Bonus accruals and payments can be
made under qualified retirement plans and other broad-based plans,
including non-qualified deferred compensation arrangements Equity
awards, such as stock options and SARs, however, generally are
prohibited forms of “incentive compensation,” as are
amounts payable upon completion of a transaction and certain cases of
forgiveness of employer-employee loans. A “clawback” rule
requires recipients to recover any bonus or incentive pay paid to an
SEO and any of the next 20 highest-paid employees that later turns out
to have been based upon financial statements or performance metrics
that were inaccurate. Recipients must annually disclose to Treasury
and their primary federal regulator any executive perks worth more
than $25,000 in the aggregate to any covered executive. The disclosure
must describe the perks and the reason they are being offered.
Recipients also must disclose to Treasury and their primary federal
regulator annually whether the recipient, its board of directors or
its compensation committee has hired a compensation consultant and, if
so, it must detail the services provided by the consultant, including
any benchmarking used to establish compensation levels.
3. Restricted Stock and RSUs. The Regulations clarify that
the statutory exemption for “long-term restricted stock”
applies to restricted stock units (“RSUs”) as well. Such
forms of equity based compensation cannot exceed one-third of an
executive's annual pay.” An executive must forfeit such a grant
if he or she terminates employment within two years of grant, unless
the termination is due to executive's death or disability or due to a
change in control of the recipient. Restricted shares may become
transferable, and RSUs may be paid, ratably in 25% increments as the
recipient repays the TARP funds to the government.
4. Severance Pay. Recipients cannot make golden parachute
payments to an SEO or any of the next five highest-paid employees
during the TARP period. All payments with change-in-control triggers
are considered parachute payments. Executives cannot circumvent this
rule by deferring such amounts beyond the TARP period. Distributions
from qualified plans, payments due to death or disability and certain
deferred compensation payments are not considered parachute payments,
nor is the government's taking over an employer's
stock.4
5. Luxury Expenses. The recipient's board of directors must
adopt a policy on “excessive or luxury expenditures,”
which must be filed with the IRS and posted on the company's website.
The policy must list prohibited types of expenditures and set forth
the approval process for permitted ones.
6. Tax Gross-Ups. The common practice of tax gross-up
payments is prohibited for senior executives of TARP recipients. No
gross-up or other reimbursement of taxes may be made to any SEO and
the next 20 highest paid employees relating to severance payments,
executive perks or similar pay. International tax equalization
arrangements, however, are not covered.
7. Compensation Committee. Recipients must establish a
compensation committee consisting of independent directors that meets
at least semi-annually to discuss executive pay. The committee is
responsible for preventing undue risks from being imposed upon the
recipient as a result of excessive executive compensation,
particularly compensation that might adversely affect the recipient's
value. The committee also must review whether any features of the
recipient's plans encourage executives to manipulate earnings and must
eliminate any such features that they uncover.
The Treasury's recent actions on executive pay, including these
Interim Final regulations and the announcement of its intent to seek
broader legislation, although well-intended, raise concerns about the
unintended consequences that such measures may have. Among them is
whether subjecting to these restrictions the very institutions that
need TARP funds will allow them to attract and retain top executive
talent to unravel their problems. Some financial institutions already
have repaid their TARP money to the government, so it is no longer
true that executives lack alternatives for employment that effectively
force them to remain at TARP covered institutions. Second, one way
that Treasury apparently intends to deal with the foregoing problem,
and of excessive executive compensation in general, is by imposing
similar limits on the top executives of all publicly traded companies.
This may motivate many publicly traded companies to go private and it
is precisely in the area of private capital where opaque disclosure
significantly contributed to the current economic crisis.
Clearly there have been abuses in the area of executive
compensation, some on a staggering scale. History, however, shows that
when these types of abuses occur Congress and the executive branch
have a tendency over-react to public outcry, imposing such stringent
remedies that often parties that have done no wrong and who are not
the intended targets of the measures nonetheless are caught up in
their net, becoming subject compensation restraints and burdensome
compliance requirements. Regardless of how one views about
Sarbanes-Oxley, enacted in the aftermath of the Enron, many agree
that, while SOX serves a good purpose, it also has significantly
increased the compliance costs and burden on public corporations. This
may contribute to companies taking public offerings that otherwise
might be made in New York, to London instead. Some view SOX as a
significant contributing factor to London replacing New York as the
world's financial capital. Furthermore, both London and New York face
increasing competition from the Mumbai, Dubai and Shanghai stock
exchanges. Adding additional compliance costs could accelerate the
loss of market share in financial business from the U.S. to overseas,
a disturbing trend at a time when the financial sector has come to
represent such a significant portion of the U.S. economy, even as
traditional industries, such as manufacturing, have declined.
Certainly, in light of what we have witnessed, updating our
regulatory structure is necessary to bring it into the 21st
century. It is important, however, that any such actions be targeted
to the specific abuses involved and not cast so wide a net as to deter
financial institutions and publicly traded companies from doing
business in the U.S. or to reduce the profitability of those that do.
Executive compensation arrangements, when drafted appropriately, tie
executive pay to corporate performance and thereby align the interests
of a company's executives with those of its shareholders. Equity-based
pay and executive compensation arrangements comprise a significant
segment of such executive compensation. The key is not to eliminate
these forms of compensation, but to ensure that the amount of pay is
reasonable under §162, that poor performance is not rewarded and
that company finances are not manipulated in a way that is beneficial
to executives, but not necessarily to the long-term interests of their
companies.
Arguably, we already have many of the tools at our disposal to deal
with abuses and the problem has been more the lack of enforcement than
the lack of authority.
Certainly, taxpayers would benefit by including more objective
criteria in the regulations under §162. The current “facts
and circumstances” test leaves considerable leeway and can lead
to abuse. Guidance requiring that executive compensation be related to
performance metrics that are aligned with shareholders' interests
would do much to police this problem from a tax standpoint.
Furthermore, even in the world of private capital, arguably the
problems have come from the failure of the SEC and other regulatory
agencies to keep watch over such pools of capital, although more
disclosure clearly is warranted. Finally, corporate directors and
executives owe a fiduciary duty to shareholders. It should be made
clear that this duty includes the duty to make certain that the
payment of excessive or inappropriate executive compensation does not
endanger the corporation's interests nor significantly impair
shareholder equity and that executive compensation be appropriately
aligned with shareholder interests. Again, however, this type of
regulation is available under current fiduciary responsibility
statutes in corporate law, including the duty of loyalty, so the
enforcement of existing law, coupled with increased shareholder
activism, can provide the tools necessary to curb abuses without
imposing burdensome administrative costs. Although modernization of
our financial and compensation regulatory structure is needed,
hopefully such action will not take the form of an over reaction with
negative unintended consequences, casting a broad “TARP”
of excessive regulation over law-abiding companies.
For more information, in the Tax Management Portfolios, see
Brisendine, Veal and Drigotas, 385 T.M., Deferred Compensation
Arrangements, and in Tax Practice Series, see ¶5710,
Nonqualified Deferred Compensation.
1
RIN 1505-AC09 (6/15/09).
2
P.L. 110-185.
3
P.L. 111-5.
4
See Notice 2009-49, 2009-25 I.R.B. 1093.
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