Responding to widespread public outcry over perceived mismanagement of the TARP program, the Treasury Department has issued new guidelines on executive compensation for financial institutions that receive government assistance. Most of the proposed guidelines do not apply retroactively to Treasury investments through existing programs, such as the Capital Purchase Program and the Term Asset-Backed Securities Loan Facility.

In the words of the Treasury, the new measures are “designed to ensure that public funds are directed only toward the public interest in strengthening our economy by stabilizing our financial system and not toward inappropriate private gain.” Treasury also expects the new guidelines to more closely align the interests of executives with the interests of both shareholders and taxpayers.

The guidelines include separate restrictions on banks participating in any new “generally available capital access program” and banks needing “exceptional assistance.” The term “generally available capital access program” includes programs that have the same terms for all recipients, with limits on the amount each institution may receive and specified returns for taxpayers. The previously announced Capital Purchase Program would be an example of a generally available capital access program. Assistance provided outside of a generally available capital access program would constitute “exceptional assistance.” Institutions receiving exceptional assistance would have bank-specific negotiated agreements with the Treasury, such as AIG and the Bank of America and Citi transactions under the Targeted Investment Program.

The Treasury’s announcement sets forth the following new guidelines:

I. New Compliance and Certification Rules for Current and Future Participants

The chief executive officer of any institution that has received government assistance to this point or does receive any form of government assistance in the future must provide an annual certification that the institution has strictly complied with all applicable statutory, Treasury-mandated and contractual executive compensation restrictions. This requirement supplements and does not replace the requirement of the compensation committee to certify that senior executive compensation arrangements do not encourage excessive and unnecessary risk-taking.

II. New Executive Compensation Limitations

A. Generally Available Capital Access Programs

The Treasury intends the following proposed guidance (which is subject to public comment) to apply to any financial institution participating in future generally available capital access programs. This guidance is not intended to apply to already announced programs, including the Capital Purchase Program.

1. Companies must limit senior executives to $500,000 in total annual compensation plus restricted stock that may not vest until the government has been repaid with interest. The Treasury may waive the requirement if the company makes full public disclosure of its compensation and, if requested, submits a non-binding “say on pay” resolution to shareholders.

2. Companies must review and disclose the reasons compensation arrangements of both senior executive officers and other employees do not encourage excessive and unnecessary risk-taking. This differs from the current Capital Purchase Program rule which extends to the compensation arrangements of only the top-five senior executive officers.

3. The potential clawback of bonuses now applicable to the top-five senior officers under the Capital Purchase Program would extend to the next twenty senior executives if they engage in deceptive practices.

4. A company may not make a golden parachute severance payment to any of the top-five executives which exceeds one year’s compensation.

5. The board of directors must adopt a policy relating to the approval of luxury expenditures.

B. Exceptional Assistance

The following proposed guidance would apply to institutions receiving exceptional assistance.

1. Companies must limit compensation of senior executives to $500,000, plus restricted stock – same as the requirement for generally available capital access programs.

2. Companies must submit a non-binding resolution to shareholders regarding the senior executive compensation structure and the rational for how it ties compensation to sound risk management (a “say on pay” resolution).

3. Companies must adopt the same clawback provisions for the top twenty-five senior executives as required for companies under the generally available capital access programs.

4. A company may not make any golden parachute severance payment to any of the top-ten senior executives and must limit severance payments for the not twenty-five senior executives to one year’s compensation.

5. The board of directors must adopt a policy relating to the approval of luxury expenditures and post the expenditure policy on the company website.

III. Other Items

In addition to the newly-proposed limitations, the Treasury has proposed taking certain steps with respect to long-term regulatory reform to align compensation strategies with proper risk management and long-term value and growth. The Treasury intends to address these reforms in a conference with shareholder advocates, major public pension and institutional leaders, policy makers, executives, academics and others. The potential reforms include:

  • Requiring compensation committees of all public financial institutions to review and disclose strategies for aligning compensation with sound risk management.

  • Requiring top-executives of financial institutions to hold stock for several years after it is awarded.

  • Allowing shareholders of all public financial institutions to vote on a non-binding resolution on both the level of executive compensation and how the structure of compensation incentives help promote risk management and long-term value creation.

IV. Rules Comparison

The following chart illustrates the differences between certain rules now in effect under the Capital Purchase Program (“CPP”) and the rules proposed for future generally available capital access programs (“GACAP”) and exceptional assistance (“EA”):

Item

CPP

EA

GACAP

Limit on Compensation

No tax deduction for compensation in excess of $500,000 for top-five executives

Total compensation payments may not exceed $500,000 (plus restricted stock) for top-five executives

Total compensation payments may not exceed $500,000 (plus restricted stock) for top-five executives – unless waived

Bonus Clawback

Requires the repayment of bonuses if the payments are based on materially inaccurate financial information or performance metrics.

Requires repayment of bonus by top twenty-five executives if the engage in deceptive practices

Requires repayment of bonus by top twenty-five executives if the engage in deceptive practices

Golden Parachute Payments

Limits golden parachute severance payments for top-five executives to three times average annual compensation for the last five years.

Prohibits golden parachute severance payments for top-ten executives; limits severance payments for next twenty-five executives to one year’s compensation.

Limits golden parachute severance payments for top-five executives to one year’s compensation.

Luxury Expenditure Policy

Not required

Required to be adopted by board of directors and posted on website

Required to be adopted by board of directors.

V. Next Steps

All financial institutions should consider the impact of the proposed changes on their executive compensation programs. Any institution applying for government assistance should also ensure it fully understands the required limitations on executive compensation. In addition, as executive compensation continues to receive heightened scrutiny, it is possible that rules which are today limited to institutions receiving federal assistance may become rules of general applicability.

Many financial institutions, both those that have applied for government assistance and others, have begun reviewing their compensation arrangements and policies. Periodic reviews of an institutions compensation arrangements and policies constitutes a sound corporate governance policy viewed favorably by regulators, shareholders and customers.

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