United States: Treasury Department And SEC Announce New Executive Compensation Initiatives - 16 June 2009

Compensation plans should properly measure and reward
performance.

Compensation should be structured to account for the time
horizon of risks.

Compensation practices should be aligned with sound risk
management.

Golden parachutes and supplemental retirement packages should be
analyzed to ensure that they align the interests of executives and
shareholders.

Transparency and accountability in the process of setting
compensation should be promoted.

Shareholder "Say on
Pay" – The administration called for
legislation giving the SEC authority to require companies to give
shareholders a non-binding vote on executive compensation packages.
(As discussed in a previous McDermott Will & Emery White
Paper, the Recovery Act requires each TARP recipient to
provide shareholders an advisory, non-binding vote on executive
compensation.) According to the Treasury Department's Fact Sheet, the
non-binding shareholder vote would permit shareholders to vote not
only on the annual compensation (salary, bonus and other
compensation) of the company's top five executives, but also on
change in control/golden parachute payments. It is widely
anticipated that the administration will be successful in having
Congress enact Say on Pay legislation for all public companies
later this year. Public companies should begin to consider changes
for next year's proxy in light of Say on Pay, including the
structure of advisory votes and how to manage shareholder
communication.

Compensation Committee Independence –
The administration indicated it would propose legislation giving
the SEC power to ensure that compensation committees are more
independent, adhering to standards similar to those in place for
audit committees as part of the Sarbanes-Oxley Act. According to
the Fact Sheet for this proposal, compensation
committees also would be given the responsibility and the resources
to hire their own independent compensation consultants and outside
counsel. The new requirements also will direct the SEC to establish
standards for ensuring the independence of compensation consultants
and outside counsel used by the compensation committee. Issues
raised by this proposal include whether existing directors serving
on compensation committees would be grandfathered (so as to avoid
the immediate need to replace directors under the new standards),
and whether directors will need to be "experts" in
compensation.

Limits on Bonus Payments – The
interim final rule limits bonuses paid to senior executive officers
(SEOs) to one-third of their total compensation. SEOs are defined
to include the "named executive officers" identified in
the company's annual compensation disclosures and a specified
number of the most highly compensated employees of TARP recipients
depending upon the amount of financial assistance the company has
received. (For those institutions receiving over $500 million in
assistance, the five SEOs and the 20 most highly compensated
employees are covered.) For purposes of applying the limits on
bonus payments, the interim final rule defines "most highly
compensated" employees by reference to total annual
compensation (not including actuarial pension increases and
above-market interest on deferred compensation amounts) as
calculated under the federal proxy disclosure rules. Commissions
paid to employees are not subject to this bonus limitation to the
extent payable under programs similar to commission programs
already in place as of February 17, 2009, which is a significant
concession that helps TARP recipients to continue to retain top
investment traders. TARP recipients will need to expand the
individuals with respect to whom the company tracks compensation,
as an employee can be subject to this restriction without being an
executive officer.

Prohibition on Payment of "Golden
Parachutes" – The Recovery Act prohibits
any golden parachute payment to a named executive officer or any of
the next five most highly compensated employees. While the Recovery
Act limited the definition of golden parachutes to payments for an
employee's departure for any reason, the interim final rule
also clarifies that any payments made in connection with a change
in control of the company are prohibited parachute payments.

Clawbacks – The Recovery Act mandates
that bonuses paid to named executive officers and the next 20 most
highly compensated employees be subject to a clawback if the
payment was based on materially inaccurate performance criteria.
The interim final rule requires that the TARP recipient enforce its
clawback rights upon a triggering event unless the TARP recipient
can demonstrate that it would be unreasonable to do so (for
example, if the expense of enforcing the clawback right exceeds the
benefits of doing so). Presumably, this determination would be made
by the compensation committee or a subcommittee of independent
directors.

Risk Analysis Required for Compensation of All
Employees – As enacted, EESA required
compensation plans for named executive officers to avoid incentives
for unnecessary risk-taking. The Recovery Act expanded that
restriction to all employee compensation plans, and also
to require that no employee compensation plan encourage the
manipulation of earnings. The interim final rule required that the
compensation committee of the financial institution provide a
narrative explanation of its analysis, allowing shareholders to
evaluate directors' reasoning with respect to the risks
presented by compensation plans. It will be up to compensation
committees to determine what type of compensation agreements avoid
incentives for unnecessary risk taking.

Luxury Expenditure Policies – The
interim final rule implements the Recovery Act's requirement
that the board of directors of each TARP recipient establish a
company-wide policy on luxury or excessive expenditures.
Specifically, the CEO and the CFO of each TARP recipient must
certify that any expenditure requiring the approval of the board of
directors or a senior executive officer (or any executive officer
of a substantially similar level of responsibility) was properly
approved, and requires that the policy mandate prompt internal
reporting of any violations of the policy.

Prohibition on Tax Gross-Ups – The
interim final rule prohibits the payment to SEOs and the 20 next
most highly compensated employees of any tax "gross-up,"
or a payment to cover taxes due on compensation such as golden
parachutes and perquisites. There is no grandfathering exception
for employment agreements entered into prior to EESA.

Additional Disclosure of Perks – TARP
recipients must disclose the type and amount of any perquisite
provided to any employee subject to the Recovery Act's
bonus limitations with total value exceeding $25,000. TARP
recipients will also be required to provide a narrative description
of, and justification for, the benefit. Currently, perquisite
disclosure is only required for named executive officers, and the
cost of an individual perquisite only needs to be disclosed if it
exceeds the greater of $25,000 or 10 percent of the total amount of
the named executive officer's perquisites.

Mandated Disclosure of Compensation Consultants
– The interim final rule requires TARP recipients to
disclose whether the company or its compensation committee engaged
a compensation consultant. It also requires TARP recipients to
provide a narrative description of the services provided by the
compensation consultant to the TARP recipient, including any
non-compensation related services provided by the consultant or any
of its affiliates, as well as a description of the use of any
"benchmarking" procedures in the consultant's
analysis. This change may be considered by the SEC in developing
guidance regarding the independence of compensation committees for
all public companies.