The Implications of Treasury's New Guidelines on Executive Pay - 9 Mar 2009

The Implications of Treasury's New Guidelines on Executive Pay

Angela Marie Hubbell
The Corporate Counselor
March 9, 2009

President Obama and Treasury Secretary Timothy F. Geithner stood together on Feb. 4, 2009, to announce the Treasury Department's new set of guidelines restricting executive compensation at financial institutions that receive governmental money. In his announcement, President Obama called the bonus payments made to senior executives in late 2008 by major financial firms that received bailout money "shameful and intolerable." He indicated that the new Treasury guidelines were issued to ensure public funds are directed toward the public's interest in stabilizing our economy and are designed to align compensation of senior executives in the financial industry with interests of both shareholders and taxpayers.

Specifically, the guidelines indicate that they were designed to strike a balance between the financial industry's need to attract top talent to lead in the current economic climate and the public's interest in requiring transparency and accountability. The guidelines require not only disclosure of but an explanation and justification of the policy supporting certain compensation decisions. The guidelines are divided into two broad categories: 1) compliance and certification; and 2) limits on executive compensation.

Due to their limited application, chances are that your company will not be directly impacted by the guidelines. The caps on executive pay apply on a prospective basis and are currently limited to the financial industry. In addition, many of the restrictions can be waived by disclosure to the shareholders. To the extend the disclosure requirements in the guidelines apply, they go beyond the reporting requirements relating to executive compensation imposed by the Securities and Exchange Commission as part of the rule-making requirements of Sarbanes-Oxley, but the changes required by the guidelines pale in comparison to the magnitude of changes to the rules governing the design of executive compensation brought about by Code Section 409A.

Importantly, the new Treasury guidelines indicate that they mark the beginning of the President's examination of the relationship between the corporate governance and compensation rules and current financial circumstances. And, the language and tone of the guidelines suggest that the current administration intends further reform of the corporate governance and compensation rules. The guidelines also contain a provision entitled long-term regulatory reform, which further suggests that additional changes to executive compensation are forthcoming.

COMPLIANCE AND CERTIFICATION REQUIREMENTS UNDER TREASURY GUIDELINES

Under the Treasury guidelines, the Chief Executive Officer of any company who receives financial assistance must certify, on an annual basis, compliance with executive compensation restrictions imposed by statute, Treasury regulation and contractual obligation. Thus, such certification would require affirmation not only of the standards imposed by the guidelines but also of those previously imposed by Code Section 409A and other laws. Additionally, the guidelines require the compensation committee of each company receiving government assistance to explain the ways in which their compensation arrangements are designed to both avert unnecessary risk taking and to reward creation of long-term value.

Although the provision related to restrictions on expenses for entertainment and holiday parties, the use of aviation services, conferences and other events, and office or facility renovations is contained under the broad category of "limits on compensation," the primary force of the restrictions come from the additional required disclosure. The guidelines require the Chief Executive Officer of all companies receiving federal funds to certify the business need for any expenditure that could be viewed as a luxury item or excessive. The guidelines expressly indicate that they are not designed to interfere with or prevent normal expenditures for normal business operations, including performance incentives, staff development, and sales conferences. Companies are also required to post the text of their expenditure policies on company Web sites, thereby mandating the policies be available not only to shareholders, but to the general public as well. This limitation appears to respond directly to the public outcry that resulted last fall when several automakers flew company planes at an estimated cost of $20,000 per round-trip flight between Detroit and Washington, DC, to request government financial assistance.

HOW WIDESPREAD?

Currently, these disclosures are only required by entities in the financial industry receiving government financial assistance. However, as mentioned above, as a consequence of the requirements of Sarbanes-Oxley, the Securities Exchange Commission now requires public entities to report compensation agreements involving executive officers and directors. The SEC also recently overhauled its executive officer and director compensation disclosure rules. Therefore, in light of language in the guidelines relating to long-term reform, it would not be surprising to see the SEC expand the disclosure requirements to include the certification requirements outlined in the guidelines for all public companies.

CONDITIONS ON EXECUTIVE COMPENSATION

The new guidelines distinguish between those entities seeking "exceptional assistance" and those that accept assistance under the generally available capital access program with respect to the conditions placed on compensation. The generally available program is essentially a "one size fits most" standard, with set terms and conditions for all recipients. It has a cap on the amount that each institution can receive and a uniform expected rate of return on taxpayer monies. The Capital Purchase Program announced last fall is an example of a generally available capital access program. Financial institutions that need assistance at a level exceeding what is available under a generally available program can apply for "exceptional assistance." Exceptional assistance programs are specifically negotiated between the institution and Treasury. Some of the entities that currently have such agreements include Bank of America, Citigroup, and AIG.

In addition, the new guidelines contain restrictions that are much stronger than the restrictions put into place last fall. Current tax law permits a business to deduct all salaries that do not exceed $1 million, and performance-based compensation is excluded from this amount. Last fall, this amount was reduced to $500,000 for amounts paid to top executives at certain financial institutions, but the limit applied only when the business had over $300 million in dealings with the government under the bailout program. As such

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