By Stuart
M. Lewis, Catherine
Creech, Keith
A. Mong, William
F. Sweetnam, Jr., and Norma
Sharara
The following is a transcript of an informal discussion of
employee benefit practitioners held in Washington, D.C., on February
19, 2009. The topic involved the new executive compensation
restrictions in the American Recovery and Reinvestment Act of 2009
(a/k/a the “Stimulus Bill”), P.L. 111-5, which was signed
into law by President Obama on February 17,
2009.
Discussion Participants
Stuart
M. Lewis, Buchanan Ingersoll
& Rooney P.C.
Catherine
Creech,Ernst
& Young LLP
Keith
A. Mong, Buchanan Ingersoll
& Rooney P.C.
William
F. Sweetnam, Jr., Groom Law Group,
Chartered
Norma
Sharara, Luse Gorman Pomerenk
& Schick, P.C.
Mr. Mong: The President signed the Stimulus Bill on Tuesday
[February 17, 2009], which includes new executive compensation and
corporate governance rules for companies participating in the
Treasury's TARP program. This essentially represents the third round
of executive compensation restrictions targeted at TARP companies. The
first round included the restrictions imposed in connection with EESA
[the Emergency Economic Stabilization Act of 2008] in October 2008.
The second round involved the revised executive compensation standards
announced by the Treasury on January 16th [2009]. This third round of
restrictions under the Stimulus Bill includes, for the first time, a
limitation on the type of compensation that can be paid - the new
rules generally provide that a TARP company cannot pay or accrue any
bonus, incentive or retention compensation while the company is in the
TARP program other than in the form of restricted stock that meets
certain conditions, including that it cannot vest until the company
exits the TARP program.
Ms. Sharara: It should be emphasized, however, that the new
rules do not impose a limit on the amount of base compensation that
can be paid. The new rules do extend the $500,000 deduction limit
under Code §162(m)(5) to all companies participating in TARP [and
not just those selling more than $300 million in assets under TARP],
but TARP companies remain free to pay whatever base compensation that
is otherwise appropriate - some just may now be nondeductible. In
response to these new rules, companies may consider restructuring
their compensation packages to provide more of the total compensation
in the form of base compensation, to replace some of the bonus or
incentive compensation that can now only be provided in the form of
restricted stock. These new rules should also be contrasted with the
revised standards announced by the Treasury in January [2009], which
generally included a $500,000 cap on the total cash compensation that
could be paid. Any compensation in excess of the $500,000 cash limit
would have had to be provided in the form of restricted stock that
could also not vest until the company exited the TARP program.
Mr. Lewis: However, the new restrictions under the Stimulus
Bill do limit the amount of restricted stock that can be provided. The
restricted stock cannot be more than one-third of the executive's
annual compensation. In addition, the new limitations on bonus and
incentive compensation do not apply to bonus payments paid under
employment contracts executed before February 12th [2009]. This could
except a lot of bonuses and incentive compensation from the new rules.
However, it is not clear how this grandfather rule will ultimately
work. For example, if an employment agreement has an annual evergreen
provision, it is not clear how long any payments made under that
agreement will continue to be excepted.
Ms. Creech: At this point, it is also not completely clear
how all of these rules fit together. For instance, the new rules under
the Stimulus Bill replace the statutory language under EESA, which
authorized a number of the executive compensation standards issued by
the IRS and Treasury in October [2008]. However, some of those
restrictions were included in new Code §§162(m)(5) and
280G(e), and therefore, those appear to still be applicable. It also
appears that the revised standards announced by the Treasury in
January [2009] have essentially been superseded by the new rules in
the Stimulus Bill. The revised standards were only announced and were
not expected to become effective until the Treasury issued additional
guidance. I guess we will have to wait and see if the Treasury tries
to resurrect in future guidance any of the revised standards
[announced in January 2009] that were not included in the Stimulus
Bill.
Ms. Sharara: The effective date of the new rules [under the
Stimulus Bill] is also not clear. As you noted, the Stimulus Bill
replaced the standards provided in EESA with the new executive
compensation restrictions. The Stimulus Bill does not include any
specific effective date language with respect to this replacement.
Thus, one interpretation is that the new rules are retroactively
effective - as if originally included in EESA. In this regard, the new
language defines the term “TARP recipient” as any entity
that has received or will receive financial assistance under TARP -
possibly suggesting a retroactive effective date for at least some of
the new rules. However, certain sections of the new rules under the
Stimulus Bill provide that the Secretary of the Treasury shall
establish standards which shall include certain specific standards,
including the limitations on bonus and incentive compensation. Thus,
there is a strong argument that those new rules do not become
effective until the Treasury actually issues guidance.
Ms. Creech: The new rules also prohibit golden parachute
payments to the top 10 executives. This new limit, unlike some of the
limitations in the prior standards, applies to the first dollar of
golden parachute payments. In certain situations, the prior standards
only applied the limit to amounts in excess of either one-times or
three-times annual compensation.
Mr. Lewis: The new rules also define golden parachute
payments broadly to include any payment for leaving a company for any
reason. In contrast, Code §280G(e) [which was added by EESA] is
limited to payments in connection with involuntary terminations,
bankruptcies and other liquidations.
Mr. Mong: How are your clients reacting to these new
rules?
Ms. Sharara: I work mostly with small to mid-size financial
institutions and not for large, national banks that you tend to see in
the headlines nowadays. In most cases, these smaller institutions are
in relatively good financial condition and do not need the TARP money
to survive. Rather, in many cases, they applied for the TARP money to
provide a cushion for possible further declines in their balance
sheets and to provide a funding source for possible acquisitions of
other banks that may be attractive in the current environment. Because
of these new rules, many of these banks are considering returning the
TARP money to avoid having to implement the restrictions. They feel
that they may not be able to retain and attract the executives
necessary to run a successful financial institution if these new
restrictions apply to their executives solely because they have TARP
money.
Mr Sweetnam: It is my understanding that a number of people
on the Hill believe that, in most cases, attracting and retaining
experienced and talented executives to run these institutions would
not be that difficult, particularly in the current economic
environment. For that reason, they did not feel that these new rules
would significantly impair a company's ability to find and retain
executives. If your experience is different from their understanding,
you may want to communicate that to those on the Hill. I think that is
an important message, particularly the fact that some of the financial
institutions are considering returning the TARP funds just to avoid
the new rules.
Ms. Creech: The new rules also include a provision that
requires the Treasury to review bonuses and other compensation that
has already been paid to the top 25 executives of the companies that
have received TARP funds. If the Treasury concludes that the
compensation was inconsistent with the purposes of TARP or otherwise
contrary to the public interest, they are supposed to negotiate with
the company and the executive in an effort to obtain a reimbursement
of the excess compensation.
Mr. Sweetnam: The new rules do not include any specific
sanctions or penalties that the Treasury can impose or other
incentives the Treasury can use in these negotiations other than the
statutory directive to pursue those amounts. In addition, it is not
clear that the Treasury has the resources to review the compensation
of all of the targeted executives, and even if they could, it is not
clear what the proper standards would be for determining whether the
compensation was excessive, particularly given the levels of
compensation commonly paid before the financial crisis came about.
Under these conditions, it is certainly not clear how this provision
can be implemented effectively.
This commentary also will appear in the May 2009 issue of the
Tax Management Compensation Planning Journal. For more information, in
the Tax Management Portfolios, see Moran, 390 T.M., Reasonable
Compensation, and in Tax Practice Series, see ¶5420,
Reasonable Compensation.
