When it comes to TARP (and by
TARP I mean the EESA, and by the EESA I mean the ARRA), everyone’s
talking about compensation limits. But there is a lot more to the new
standards imposed on recipients of TARP funds by the recent
legislation, and this is your one-stop, ten-minute guide.
What is TARP/EESA/ARRA?
TARP
is the Troubled Asset Relief Program, which was established under the
Emergency Economic Stabilization Act of 2008 (EESA). The language of
TARP was then slightly amended and finalized in the American Recovery
and Reinvestment Act (ARRA), which was signed by President Obama on
February 17, 2009.
You can access the full text of the ARRA here,
and the section on corporate governance and compensation limits -
Division B, Title VII, Section 7001 - is at the very end. You can also
access the full text of the EESA here.
What are the corporate governance requirements under TARP as amended?
All
TARP recipient companies are required to establish and follow certain
standards. Some are pretty non-controversial, while others might
surprise you.
- Unnecessary and Excessive Risks
- Limits on incentives that encourage Senior Executive Officers (SEOs)
to take “unnecessary and excessive risks that threaten the value” of
the company while TARP funds are still owed.
- Clawbacks
- Recovery of any bonus paid out to a SEO or the next 20 most
highly-compensated employees, if that bonus was “based on statements of
earnings, revenues, gains, or other criteria that are later found to be
materially inaccurate.”
- Golden Parachutes
- Prohibition on any golden parachute payment made to a SEO or the next
5 most highly-compensated employees paid out while TARP funds are still
owed. “Golden parachute payment” is defined in the previous section as
“any payment to a senior executive officer for departure from a company
for any reason, except for payments for services performed or benefits
accrued.”
- Long Term Restricted Stock
- Prohibition of any bonus or incentive compensation other than
long-term restricted stock, provided that the stock does not fully vest
while TARP funds are still owed, and is not greater than 1/3 of the
receiving employee’s total annual compensation. This one is unique,
however, because the amount of employees it applies to depends on how
much in TARP funds the company has received. The number is a sliding
scale between 1 and 20, but each level includes a clause that states
“or such higher number as the Secretary may determine is in the public
interest” - hence the numbers are just a minimum guideline.
- Manipulation of Reported Earnings (or
what I like to call the “duh” provision) - Prohibition of any
compensation plan that would “encourage manipulation of the reported
earnings” so as to increase compensation of any of employees.
- Compensation Committees -
Establishment of a Board Compensation Committee that is “comprised
entirely of independent directors” and meets at least semi-annually.
TARP recipients that are privately-held may have their Board of
Directors stand in for the independent compensation committee.
- Luxury Expenditures
- Establishment of a “company-wide policy regarding excessive or luxury
expenditures” such as “entertainment or events; office and facility
renovations; aviation or other transportation services.” (See Bank of America, Northern Trust, Merrill Lynch, the Auto CEOs, et al. I think we’re all pretty familiar with why this section was necessary.)
- Certification of Compliance -
The CEO and CFO of each TARP recipient has to file a certification of
compliance; if the company is publicly traded, the compliance
certification goes with the annual SEC filings. As those of us who have
taken Securities Regulation know, certifying compliance can be a
painstaking and risk-laden process, but that’s why you keep attorneys
around.
Now here are some of the more interesting requirements:
- Say-on-Pay
- All TARP recipients must institute a say-on-pay policy. A say-on-pay
provision is a non-binding advisory vote by shareholders on executive
compensation plans as disclosed in the CD&A section of SEC filings.
Boards do not have to follow the results of the shareholder vote, but
are strongly encouraged to do so. Say-on-pay has had some momentum in
recent years, mostly from institutional investors, but this is the
first time the practice has been mandated in any way.
- Retroactive Review of Executive Compensation
- The Treasury must review all “bonuses, retention awards, and other
compensation” paid out to SEOs and the next 20 most highly-compensated
employees for each TARP recipient to “determine whether such payments
were inconsistent with” the purposes of TARP or contrary to the public
interest. If the Treasury finds inconsistency, they will negotiate
appropriate reimbursement to the federal government. Okay, but here’s
the catch - while most people are assuming that the Treasury is only
going to be reviewing 2008 and 2009 bonuses, there is no actual time
limit to retroactivity set out in the legislation. While a recipient
could argue that bonuses paid out before 2008 were irrelevant to the
current economic crisis or to the compensation limits in the
legislation, the Treasury still retains the right to review any
compensation practices for the applicable employees going back in time
indefinitely.
- Repayment -
This section was added to the legislation after opponents of Barney
Frank’s amendments (say-on-pay) argued that we were getting ahead of
ourselves in oversight. Therefore, TARP recipients reserve the right to
repay TARP funds “without regard to whether [they have] replaced such
funds from any other source.” Also, the Treasury must liquidate
warrants associated with the recipient’s funds at the current market
price. While understandable that the emphasis here is on repayment,
this provision has the potential to be incredibly dangerous.
So what now?
Look
for more discussion on say-on-pay initiatives. Say-on-pay is a very
effective way for boards to give the appearance of relinquishing
control over executive compensation while not really being bound to the
shareholders’ decision. But it also carries the power to make boards
accountable by highlighting situations when they choose to override
shareholders’ decisions, and perhaps pay the consequences with a proxy
fight.
Also, it will be
interesting to see the how the final section on repayment plays out. I
know we’re getting ahead of ourselves discussing repayment already, but
the fact that TARP recipients themselves have the power to decide how
and when repayment takes place puts the spotlight squarely on the
corporate boards who are seen as having created the mess in the first
place.