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Newly Released TARP Standards for Compensation and Corporate Governance – What You Need to Know and Do Now. June 24, 2009. How did we get here?. Background on TARP & Executive Compensation . Emergency Economic Stabilization Act of 2008 (EESA) October 2008 law
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Newly Released TARP Standards for Compensation and Corporate Governance – What You Need to Know and Do Now June 24, 2009
Background on TARP & Executive Compensation Emergency Economic Stabilization Act of 2008 (EESA) October 2008 law Restrictions based on nature of participation (direct or auction purchase) Troubled Asset Relief Program (TARP) The overall program providing relief October 20, 2008 regulations for three types of programs Capital Purchase Program (CPP) The specific program funding banks through capital infusions February 4, 2009 Treasury Guidelines $500,000 salary cap, plus restricted stock American Reinvestment and Recovery Act of 2009 (ARRA) February 2009 law, amended §111 of EESA More restrictive than original EESA and Feb 4, 2009 Treasury Guidelines (but no salary cap) Interim Final Rule – Released June 10, 2009, effective June 15, 2009 Supersedes: October 20, 2008 interim regulations and February 4, 2009 Treasury Guidelines
Interim Final Rule - TARP Standards for Compensation Limits bonuses, incentive compensation and retention awards Curtails the payment of “golden parachutes” (broadly defined) Imposes a clawback for any “bonus payments” based on materially inaccurate performance criteria Extends required risk analysis of compensation to all employees of TARP recipients (not just SEOs) Requires a policy on luxury expenditures for all TARP recipients Reaffirms "Say on Pay" requirement for all TARP recipients Prohibits tax gross-ups (new) Requires additional perk disclosure (new) Mandates enhanced disclosure of compensation consultants (new) Appoints a Special Master to review pay and compensation programs at firms receiving exceptional assistance and interpret the TARP rules (new)
Special Master New “Office of the Special Master for TARP Executive Compensation” Kenneth Feinberg, noted DC attorney, is named to the post Authority to interpret §111 of EESA and applicable rules; may render advisory opinions for any TARP recipient Authority to review payments and compensation plans of companies receiving exceptional financial assistance AIG, Citigroup, BofA, Chrysler, GM, GMAC, Chrysler Financial Reviews pay and compensation structure for the SEOs and HCEs covered by the bonus limitation, and may reject if he finds it to be inappropriate, unsound or excessive, based on certain guiding principles Reviews compensation structure (but not pay) for other executive officers and 100 highest paid employees who are not covered by the bonus restriction Entrusted with negotiating reimbursement for payments made prior to Feb 17, 2009 by any TARP recipient if he finds them to be inconsistent with the purposes of §111 of EESA or otherwise contrary to public interest, based on the guiding principles
Guiding Principles for Special Master Risk: Compensation should avoid incentives that reward employees for short-term or temporary increases in value or performance that may not ultimately be reflected by an increase in the long-term value of the TARP recipient Taxpayer Return: Compensation should reflect the need for the TARP recipient to remain a competitive enterprise, retain talented employees, and ultimately repay TARP obligations Appropriate Allocation: Compensation should be appropriately allocated among each element of pay (e.g. salary, short- and long-term incentive pay, and current and deferred compensation or retirement pay) Performance-Based Compensation: Compensation should be performance-based, and determined through tailored metrics that encompass individual performance and/or the performance of the TARP recipient or relevant business unit Comparable Structures and Payments: Compensation should be consistent with, and not excessive in comparison to, pay for those in similar roles at similar entities Employee Contribution: Compensation should reflect the current or prospective contributions of the employee to the value of the TARP recipient
Who are covered employees? These requirements apply to senior executive officers (SEOs) and certain highly compensated employees (HCEs) The interim final rule does not limitapplication of the requirements to executive officers: ARRA statutory language refers to most highly compensated “employees” Defines SEOs as the “named executive officers” as defined in the SEC proxy rules; therefore often may be more than 5 individuals (broader than ARRA) Private and small reporting companies that are TARP recipients must identify 5 SEOs even if they do not have to report 5 under SEC regulations Defines “most highly compensated employees” by reference to “total annual compensation” as calculated under the SEC regulations for SEOs HCEs are based on annual compensation for last completed fiscal year If a TARP recipient is acquired by a non-TARP recipient, the acquirer does not become subject to TARP rules. Target’s employees cease to be subject to TARP after the acquisition (unless intent is to evade these rules)
Prohibitions and Restrictions Bonuses, Incentive Compensation and Retention Awards Golden Parachutes Tax Gross-Ups Tax Deductions
Restriction on Bonuses, Incentives & Retention Awards The interim final rule prohibits a TARP recipient from paying or accruing any “bonus, incentive compensation or retention award ” to certain employees These restrictions depend on amount of TARP funds received Less than $25 million – Most highly-compensated employee (CEO?) $25 to $250 million– 5 most highly-compensated employees (SEOs?) $250 to $500 million –SEOs plus next 10 most highly-compensated employees $500 million or more –SEOs plus next 20 most highly-compensated employees Definitions Bonus: any payment in addition to any amount payable for service performed at a regular hourly, weekly or other periodic rate; excludes some commissions Incentive compensation: any payment that is based on performance of employee or the TARP recipient, including options and stock awards; excludes some commissions Retention award: any payment that is contingent on completion of a period of future services or a specific project, but is not payable periodically to an employee for services performed or based on performance of employee or TARP recipient; includes hiring bonuses or “make whole” awards “Bonus payments”: as used in the rule is short-hand for all of the above (can be confusing)
Whether an employee has accrued a bonus, incentive compensation or retention award is determined by facts and circumstances The rule contains language to prevent circumnavigating these limitations (such as, no payment after-the-fact for service during the covered period) Accruals related to a multi-year period (or first year of TARP participation) Some portion may be excluded from the prohibition The payment may be made if the compensation is reduced for the portion of the period in which the employee was subject to the TARP prohibition If the employee is subject to the TARP prohibition at the time the exempt portion of the bonus would normally be paid, payment to the covered employee must be delayed until payment is permitted under TARP Treasury and IRS have advised that the delay of a payment until a recipient of the payment is no longer subject to the prohibition will not result in a “subsequent deferral” under §409A. A payment that was intended to be a short-term deferral will not be treated as a payment of deferred compensation, so long as the payment is made promptly after the TARP prohibition ceases to apply Restriction on Bonuses, Incentives & Retention Awards
Exceptions to Restriction on Bonuses & Incentives TARP recipient is permitted to award long-term restricted stock or restricted stock units (which can be settled in stock or cash) Restricted stock/RSU value can be no greater than 1/3 total annual compensation for year of grant Definition of total annual compensation includes the fair market value (on grant date) of all equity granted in that fiscal year This differs from definition used to determine “total annual compensation” in SEC proxy disclosures and determination of SEO and HCE status for TARP purposes Vesting Requirements: Restricted stock or RSUs must not “fully vest” until TARP recipient repays all TARP funds Employee must provide service for at least 2 years after the date of grant (other than in the case of death, disability or a qualifying change in control) for award to become non-forfeitable For each 25% of TARP funds repaid, 25% of restricted stock may become transferrable (or payable, in the case of RSUs) Limited transfer is permitted to cover taxes for restricted stock that becomes non-forfeitable before that May define a longer vesting period or additional performance-based requirements
Exceptions to Restriction on Bonuses & Incentives Certain grandfather rules apply to payment and accrual of bonuses, incentive compensation and retention awards: TARP recipient is permitted to pay bonuses, etc. to which an employee had a legally binding right under a valid written contract executed on or before February 11, 2009 Bonuses, etc. paid or accrued before June 15, 2009 are exempt (now we know!); but only the portion of an award that accrued or was paid before June 15, 2009 e.g., a restricted stock award granted on March 1, 2009 that vests ratably over three years would be exempt only for the portion (if any) that accrued prior to June 15, 2009 If the employee is subject to the TARP prohibition at the time the exempt portion of the award would normally be paid, payment to the covered employee must be delayed until payment is permitted under TARP
Impact on Commission Plans Certain commission payments will not be subject to the bonus restrictions provided that: They are consistent with plans in effect before February 17, 2009 The commission payouts are reasonable A substantial portion of the services by that employee consists of direct sales of a product or service to unrelated customers The sales occur frequently and in the ordinary course of business (i.e., not a specific transaction, such as an IPO or acquisition) The commission is a portion of the purchase price for the product or service sold or an amount calculated by volume of sales The commission exemption does not cover investment banking fees, proprietary trading, sales to affiliates, or commissions based on specific transactions or deals Any commission program implemented after February 17, 2009 would be subject to the bonus restrictions in the new rule
Golden Parachute Payments Prohibited Golden parachutes to any SEOs and the next 5 most highly compensated employees are prohibited This includes any payment for departure for any reason does not permit up to 2.99 times “base amount”, as originally provided under EESA not limited to involuntary termination or terminations in connection with financial downturns, as originally provided under EESA Includes any amounts due upon a change-in-control event (i.e., “single-trigger” arrangements) Includes early vesting of equity awards or other compensation upon departure or a change in control Excludes qualified retirement plans, death or disability payments, and severance payments required by statute or foreign law Excludes payments for “services performed and benefits accrued” (as defined) Limited exclusions for payment from benefit plans and deferred compensation plans A golden parachute is treated as paid at the time of employee’s departure, regardless of when amounts are actually paid, and valued at the aggregate present value
Tax Gross-Ups Prohibited Gross-ups or any reimbursements of taxes to any SEOs and the next 20most highly compensated employees are prohibited Change-in-control excise taxes Income tax on perquisites §409A taxes any other taxes (other than tax-equalization payments to compensate employees subject to non-US taxes) Providing a right to a gross-up after the TARP period ends is also prohibited The prohibition on gross-ups is new in the interim final rule and is not specified in ARRA
Tax Deduction Limitation Limitation on Tax Deduction - $500,000 per year for SEOs Compensation includes incentive compensation and deferred compensation No exemption for performance-based compensation Under October 20, 2008 interim regulations, CPP participants had to agree to be subject to this tax limitation (Code §162(m)(5)) ARRA made the limit mandatory on all TARP recipients, effective as of February 17, 2009
Clawback Policy Clawback (recovery) provision must be in place for the SEOs and next 20 most highly compensated employees Applies to both public and private TARP recipients Clawback is required if payment of any bonus, incentive compensation or retention award was based on materially inaccurate financial statements or any other materially inaccurate performance criteria Any inaccuracy is deemed material with respect to an employee who knowingly provided inaccurate information In other cases, the materiality can depend on whether inaccuracy resulted in a materially different result than would otherwise have been the case TARP recipient must exercise its clawback rights unless it can demonstrate that it is unreasonable to do so (e.g., the cost of recovery exceeds the amount recoverable) Clawback applies if the legally binding right to the payment occurs during the TARP period, even if paid after the end of the TARP period
Excessive or Luxury Expenditures Policy No later than September 13, 2009 or 90 days after taking TARP money, the board of directors of a TARP recipient must adopt a policy on excessive or luxury expenditures Board must determine what are “excessive and luxury” expenditures and establish requirements specific to the TARP recipient under this policy, including entertainment or events office and facility renovations aviation and other transportation services other similar items, activities or events The policy must establish reasonable approval procedures and annual CEO/CFO certification of compliance The policy must be posted on company’s website and filed with the Treasury and the company’s primary federal regulator
Other Administrative Requirements A wholly-independent compensation committee is required Private companies with no securities registered with SEC and receiving $25M or less may have a compensation committee or delegate the duties of the compensation committee to the board of directors Annual non-binding shareholder resolution on SEO compensation (Say on Pay) TARP recipient must annually disclose its compensation consultant to Treasury and its primary federal regulator The services engaged by management, the board or the compensation committee in the past 3 years, including benchmarking analyses and peer groups TARP recipient must annually disclose to Treasury and its primary federal regulator perquisites whose total value exceeds $25,000 for each of the SEOs and any employee who is subject to the limitations on bonus payments The amount and nature and justification for offering these perquisites
Responsibility of the Compensation Committee Within 90 days after receiving TARP, most recipients must establish a compensation committee of independent members of the Board (Private banks receiving less than $25M can use the whole Board) Every six months, the Compensation Committee (or Board for smaller companies) must review not only the executive officer compensation plans, but all employee compensation plans with the senior risk officer These discussions are intended to identify and eliminate any features that: Encourage the SEOs to take unnecessary and excessive risks that threaten value of the TARP recipient Unnecessarily pose risks to the TARP recipient Encourage behavior focused on short-term results and not on long-term value creation Encourage the manipulation of reported earnings to enhance the compensation of any employee
Annually, the Compensation Committee must provide certification of compliance and a narrative description explaining how any risks have been limited or eliminated SEC reporting companies must put provide this in their Compensation Committee Report and separately to the Treasury Smaller reporting companies and private institutions must provide this to their primary regulatory agency and to the Treasury Responsibility of the Compensation Committee
How to Ensure Long-Term Value and Reduce Risk Ensure performance targets are not too low or too high Using a variety of internal and external performance measures and not just stock price or net income. Sustainable Growth Risk Management Measures Asset Quality Individual Performance Assessments Utilize Peer Group Comparisons Incorporate Stock Holding Requirements Utilizing Long-Term Incentive Plans where value is lost if performance is not sustained over time. Implement Risk Management policies that empower the risk manager with the tools and authority to ensure sound compensation practices
CEO & CFO Certification Within 90 days after the completion of each fiscal year within the TARP period, the CEO and CFO must provide the following certifications (models are provide in the interim final rule): The Compensation Committee has met at least every 6 months with the senior risk officers to discuss and review SEO and employee compensation plans, the risks these plans pose and how they have limited any features that encourage risk or manipulation of earnings The Compensation Committee will certify to these reviews annually and provide the required narrative description in its annual report The company has required that all bonuses, incentive compensation and retention awards to the SEOs and next 20 most highly compensated employees be subject to a claw-back provision The company has prohibited payment of any golden parachute payment to the SEOs and the next 5 most highly compensated employees The company has limited bonuses, incentive compensation and retention awards as required by the interim final rule The company has complied with the applicable “say on pay” non binding vote
CEO & CFO Certification- continued The company has adopted and maintains an excessive or luxury expenditures policy and its employees and the board have complied with the policy throughout the year The company will disclose the amount, nature, and justification for the offering of any perquisites whose total value exceeds $25,000 for each of the employees subject to the bonus payment limitations Disclosure on whether the company, the board, or the compensation committee has engaged a compensation consultant, and the services provided by consultant The company has prohibited any tax gross-ups on compensation to the SEOs and the next 20 most highly compensated employees The company has substantially complied with any compensation requirements set forth in the agreement with the Treasury Identifying the SEOs and most highly compensated employees for the current fiscal year based on their compensation during the prior fiscal year Acknowledging that a knowing and willful false or fraudulent statement made in connection with the certification may be punished by fine, imprisonment or both
Effective Date Provisions The interim final rule became effective on June 15, 2009 Supercedes any previous guidance applicable to a TARP recipient, to the extent inconsistent, but only from and after June 15, 2009 Specifically, the bonus payment and golden parachute limitations under the interim final rule do not apply to payments made or accrued prior to June 15, 2009
QUESTIONS? Michael Blanchard 678-461-9016 direct email@example.com Diana Chase 404-228-1013 direct firstname.lastname@example.org Mike Stevens 404-881-7970 direct mike,email@example.com Laura Thatcher 404-881-7546 direct firstname.lastname@example.org email@example.com
Consultant Biographies Mr. Michael Blanchard - Partner 678-461-9016 direct firstname.lastname@example.org Mr. Michael Blanchard is a Partner of Blanchard, Chase & Associates. He has extensive experience in the human resources field, and has conducted or supported over 500 compensation planning, market research, and organizational development projects over the past fifteen years, with over 10 years specific to the banking industry. Before founding Blanchard, Chase & Associates, Mr. Blanchard was a Managing Director with Amalfi Consulting, a Vice President for Clark Consulting, and worked for two national firms, both specializing in decision support consultation for management and board of director clients. With graduate studies in advanced industrial and organizational psychology, Mr. Blanchard’s experience includes advising clients on compensation planning, performance appraisals, and management development.
Consultant Biographies Ms. Diana Chase – Partner 404-228-1013 direct email@example.com Diana Chase is a Partner of Blanchard, Chase & Associates. Before starting Blanchard, Chase & Associates, Ms. Chase was a Vice President at Amalfi Consulting and a Senior Consultant at Clark Consulting. She has been serving the banking industry since 2003. Prior to this, Ms. Chase worked with other industries as both an independent consultant and as a Compensation Consultant for Watson Wyatt. She has been advising clients on compensation and organizational development issues for the past fifteen years. Areas of expertise include executive compensation, incentive plan design and performance management. As an independent consultant she worked with organizations on leadership development, succession planning, and change management. Ms. Chase is a Certified Compensation Professional (CCP) and obtained her Master’s Degree in Industrial/ Organizational Psychology from The University of Tennessee.
Lawyer Biographies Michael Stevens - Partner 404-881-7970 direct firstname.lastname@example.org Mike Stevens is a partner in the Employee Benefits and Executive Compensation group at Alston & Bird. He focuses on executive compensation matters and the many tax, securities, and corporate governance issues that arise in connection with compensation arrangements. Mike advises boards, management, and individual executives with regard to stock, incentive, and deferral plans; executive employment and change in control agreements; and SEC reporting, registration, and liability relating to compensation arrangements and benefit plans. He frequently advises clients with respect to executive compensation issues relating to mergers and acquisitions and other corporate transactions.
Laura Thatcher - Partner 404-881-7546 direct email@example.com Laura Thatcher heads Alston & Bird’s executive compensation practice. A frequent speaker and author on executive compensation, Laura’s articles and interviews appear in numerous national publications. She recently co-authored the Compensation Committee Handbook, 3rd edition (John Wiley & Sons, 2008), which serves as a guidebook to executive compensation strategies and practices. Laura serves as Chair Elect of the Advisory Board of the Certified Equity Professional Institute (CEPI) of Santa Clara University. She is listed in Best Lawyers in America and Georgia Super Lawyers magazine, and serves on the Executive Compensation Task Force of CompensationStandards.com, which is dedicated to promoting responsible compensation practices. She chaired the Compensation Committee of a regional construction and development company from 1994 to 2008 and has served on the editorial board of the Journal of Deferred Compensation (Aspen Publishers) since 1998. Lawyer Biographies
Newly Released TARP Standards for Compensation and Corporate Governance – What You Need to Know and Do Now June 24, 2009