Executive Compensation Alert
June 2009
Authors:
Contributors from the
Executive Compensation
Emerging Issues Task Force
K&L Gates is a global law firm with
lawyers in 33 offices located in North
America, Europe, Asia and the Middle
East, and represents numerous GLOBAL
500, FORTUNE 100, and FTSE 100
corporations, in addition to growth and
middle market companies,
entrepreneurs, capital market
participants and public sector entities.
For more information, visit
www.klgates.com.
New TARP Executive Compensation Rules –
Who’s Covered and Who’s Not?
The U.S. Treasury Department recently issued its Interim Final Rule on the executive
compensation provisions of the Emergency Economic Stabilization Act of 2008
(EESA), as amended by the American Recovery and Reinvestment Act of 2009.
These new executive compensation standards apply to entities that receive financial
assistance under the Troubled Asset Relief Program (TARP).
The new standards impose significant burdens on affected entities, including
prohibitions on bonus and equity incentive awards for senior executives and other
key employees and numerous governance requirements. The question many
companies have to ask is this – are the benefits of receiving financial assistance
outweighed by the associated burdens, especially the executive compensation
requirements? For companies that have already received financial assistance, many
are wondering whether it would be prudent to repay the government as a means of
escaping many of these burdens. Notably, in mid-June, ten financial institutions
repaid approximately $68 billion in TARP funds.
This Alert focuses on two fundamental threshold questions: (1) which entities and
programs are generally covered by the executive compensation standards under
TARP; and (2) which TARP requirements apply to which entities, and when do
covered entities escape such coverage?
Which entities and programs are generally covered by the
executive compensation standards under TARP?
General Rule. In general, in order to be covered by the executive compensation
standards under TARP, entities must be “TARP recipients.” The Interim Final Rule
generally defines a “TARP recipient” as any entity that has received or holds a
commitment to receive “financial assistance.” The Interim Final Rule defines
“financial assistance” as any funds or funds commitment provided through the
purchase and/or insurance of troubled assets under TARP, but the definition
specifically excludes any loan modification programs under TARP. Importantly, the
Interim Final Rule makes it clear that recipients of loans from the Federal Reserve
Bank of New York’s Term Asset-Backed Securities Loan Facility (TALF) are not
TARP recipients subject to the applicable executive compensation requirements.
Application to Related Entities. In addition, the Interim Final Rule clarifies that
the term “TARP recipient” includes any entity that is treated as the same employer as
the entity that is receiving financial assistance under applicable U.S. Internal
Revenue Code controlled-group rules, but with some important modifications,
including (i) substituting a 50% combined voting power and/or total value threshold
for the 80% threshold (that applies under the Code), and (ii) disregarding the
applicable brother-sister controlled-group and combined group rules.
Executive Compensation Alert
Particularly in light of the complexity of the
corporate organizational structures that often exist
within financial institutions, it is critical for TARP
recipients to focus on these controlled group rules to
determine which entities will be subject to the
executive compensation standards, even if such
entities are not the direct recipients of financial
assistance from Treasury. For example, a joint
venture with a TARP recipient could be structured in
such a way to make the joint venture itself a TARP
recipient, even though it never directly benefits from
TARP funds.
Mergers & Acquisitions. The Interim Final Rule
makes clear that if a TARP recipient is acquired (by
way of merger, asset purchase or otherwise) by an
unaffiliated entity, the acquisition will not, by itself,
cause the acquirer to become subject to the
executive compensation standards under TARP. In
addition, if the acquirer is not subject to these rules,
then the employees of the acquirer on a posttransaction basis (which include the original target’s
employees who become the acquirer’s employees in
connection with the acquisition) will not be subject
to the executive compensation standards either.
Program Examples. The Interim Final Rule helps
clarify whether participants under the common
TARP programs are subject to the new executive
compensation requirements. For example, the
Interim Final Rule provides that participants selling
preferred stock to Treasury under the Capital
Purchase Program are “TARP recipients,” and
covered by the new rules, while participants posting
collateral and receiving loans from the Federal
Reserve under TALF, and the servicers of mortgage
loans and mortgage-backed securities participating
in the Home Affordable Modification Program, are
not “TARP recipients,” and, accordingly, are not
subject to these new TARP rules. It appears likely
that participants selling preferred stock to Treasury
under the Capital Assistance Program would be
considered to have received financial assistance and,
therefore, would be “TARP recipients.”
Anti-Abuse Rule. The Interim Final Rule also
contains an anti-abuse rule to ensure that the term
“TARP recipient” includes any entity related to a
TARP recipient to the extent that the primary
purpose for the creation or utilization of such entity
is to evade the executive compensation rules under
TARP. Also, notwithstanding the general rule that
an acquirer of a TARP recipient does not
automatically become a TARP recipient itself as a
result of the acquisition, if the primary purpose of
the transaction is to avoid or evade the application
of the executive compensation standards under
TARP, then the acquirer will be treated as a TARP
recipient immediately upon such acquisition.
However, whether or not participants and related
entities in the Public-Private Investment Program are
deemed to be “TARP recipients” involves a more
complex analysis. While the Interim Final Rule
provides that public-private investment funds that
receive financial assistance from Treasury are TARP
recipients, asset managers can avoid being
considered TARP recipients if structured properly
(for example, by not being employees of, or
controlling investors in, such public-private
investment funds). In addition, investment advisors
and/or entities that sell securities to, or buy securities
from, public-private investment funds generally will
not be deemed to be TARP recipients, although the
specific relationships of the various parties should be
reviewed. Lastly, whether or not private investors in
public-private investment funds could be TARP
recipients hinges on the controlled-group rules
discussed above.
The Interim Final Rule divides TARP recipients
into two broad categories: those with outstanding
“obligations” and those with commitments to
receive “obligations.” The actual provisions
applicable to TARP recipients with outstanding
obligations vary depending upon a number of
factors, including the amount of financial assistance
received and whether or not the TARP recipient is
publicly owned.
Which TARP requirements apply to
which entities, and when do covered
entities escape such coverage?
The term “obligation” is defined under the Interim
Final Rule as a requirement for, or an ability of, a
TARP recipient to repay financial assistance
received from Treasury. The term specifically
includes debt securities and redeemable equity
securities. It is worth noting that the Interim Final
Rule provides that warrants to purchase common
stock issued by a TARP recipient are explicitly
excluded from the definition of the term
June 2009
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Executive Compensation Alert
“obligation,” but the Interim Final Rule also
provides that common stock of a TARP recipient
owned by the Federal government is considered an
obligation for purposes of determining applicability
of these executive compensation rules. We suspect
that Treasury does not intend for common stock
issued upon the exercise of warrants to be
considered obligations under the Interim Final Rule,
but the Interim Final Rule contains seemingly
contradictory provisions on this point. This
contradiction would be purely academic if Treasury
sells common stock issued upon exercise of a
warrant immediately after exercise, as most other
investors would normally do.
The more onerous requirements in the Interim Final
Rule only apply to those TARP recipients with
outstanding obligations, but only for the period
during which such obligations remain outstanding.
Some of the key requirements include:
•
Substantive compensation limits
o
•
•
Prohibition on paying or accruing any
bonus, retention or incentive compensation
for senior executives and certain other
highly compensated individuals, with
limited exceptions
o
Prohibition on “golden parachute” (i.e.,
severance) payments
o
Prohibition on tax gross-ups
o
Clawback/recovery provisions
Enhanced governance requirements
o
Establishment of independent compensation
committee and semi-annual meetings to
discuss and evaluate compensatory plans in
light of an assessment of any risk posed to
the TARP recipient from such plans
o
Annual CEO and CFO compliance
certifications
o
Shareholder approval of executive
compensation (Say-on-Pay)
Enhanced disclosures
o
Narrative discussion in proxy statement
regarding compensation committee’s
assessment of risks posed by compensation
plans
o
Website disclosure of policies with respect
to luxury expenditures
o
Disclosures to Treasury and primary
regulator regarding certain material
perquisites and compensation consultant
independence
For TARP recipients who only have a commitment
to receive financial assistance but have no
outstanding obligations, only the requirements to
have an independent compensation committee and
to adopt and publish a policy regarding luxury
expenditures apply, and these limited requirements
continue to apply until the last day of the TARP
recipient’s fiscal year that includes the EESA
authority’s sunset date (i.e., December 31, 2009 or
such later date as determined by the Secretary of the
Treasury up to October 3, 2010).
TARP recipients should be particularly mindful of
the following practical consequences of the Interim
Final Rule standards.
First, golden parachute/severance payments for
senior executives and certain other highly
compensated employees that accrue due to a
termination of employment during the time that an
entity has TARP obligations outstanding may never
be paid (even after the TARP period has ended).
Second, as a practical matter, entities subject to the
standards under the Interim Final Rule may come
under pressure to continue their compliance with
many of the executive compensation TARP
requirements even after the obligations are repaid.
For example, it may be difficult for entities that
have established independent compensation
committees, clawback/recovery policies and luxury
expenditure policies pursuant to the Interim Final
Rule to discard those practices or policies simply
because the TARP obligations have been repaid. It
would not be surprising if some of the governance
provisions under the Interim Final Rule evolve into
best practices over time, not only for TARP
recipients but for all financial institutions, and
possibly for businesses at large. Our upcoming
Alert entitled “The Economic Crisis: Broader
Executive Compensation Reform Coming Soon”
will discuss these and other issues.
June 2009
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Executive Compensation Alert
The executive compensation standards and
requirements under the Interim Final Rule are
complex and companies should be working with
legal counsel to determine what the requirements are
and how best to comply with them.
The Firm has an Executive Compensation Emerging
Issues Task Force, which is an interdisciplinary
group comprised of lawyers from our Executive
Compensation, Financial Services, Labor &
Employment, Litigation and Public Policy practices
in both our U.S. and U.K. markets. This Task Force
is exploring in detail the evolving regulatory and
marketplace responses to the executive
compensation concerns arising out of the global
economic crisis. If you have any questions, please
do not hesitate to contact the K&L Gates attorney
with whom you regularly work, or one of our
members of the Task Force below.
Executive Compensation Emerging Issues Task Force Members
Executive Compensation:
James E. Earle
Douglas J. Ellis
Ian Fraser
Charles A. Grace
Victoria Green*
Julia R. Rhue*
Raleigh A. Shoemaker
Lynne S. Wakefield
jim.earle@klgates.com
douglas.ellis@klgates.com
ian.fraser@klgates.com
charles.grace@klgates.com
victoria.green@klgates.com
julia.rhue@klgates.com
raleigh.shoemaker@klgates.com
lynne.wakefield@klgates.com
+1.704.331.7530
+1.412.355.8375
+44.020.7360.8268
+1.617.951.9073
+44.020.7360.8202
+1.704.331.7567
+1.704.331.7457
+1.704.331.7578
Financial Services:
Danny Asher Brower
Sean P. Mahoney
danny.brower@klgates.com
sean.mahoney@klgates.com
+44.020.7360.8120
+1.617.261.3202
Labor & Employment:
Rosemary Alito
Patrick M. Madden
Laura J. O’Brien*
Daniel Wise
rosemary.alito@klgates.com
patrick.madden@klgates.com
laura.obrien@klgates.com
daniel.wise@klgates.com
+1.973.848.4022
+1.206.370.6795
+44.020.7360.8227
+44.020.7360.8271
Litigation:
Thomas F. Holt, Jr.
thomas.holt@klgates.com
+1.617.261.3165
Public Policy:
Daniel F.C. Crowley
Karishma Shah Page*
dan.crowley@klgates.com
karishma.page@klgates.com
+1.202.778.9447
+1.202.778.9128
*Associate Task Force member
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K&L Gates is a global law firm with lawyers in 33 offices located in North America, Europe, Asia and the Middle East, and represents numerous
GLOBAL 500, FORTUNE 100, and FTSE 100 corporations, in addition to growth and middle market companies, entrepreneurs, capital market
participants and public sector entities. For more information, visit www.klgates.com.
K&L Gates comprises multiple affiliated partnerships: a limited liability partnership with the full name K&L Gates LLP qualified in Delaware and
maintaining offices throughout the U.S., in Berlin and Frankfurt, Germany, in Beijing (K&L Gates LLP Beijing Representative Office), in Dubai,
June 2009
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Executive Compensation Alert
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in regard to any particular facts or circumstances without first consulting a lawyer.
©2009 K&L Gates LLP. All Rights Reserved.
June 2009
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