Friday, February 27, 2009

Corporate Governance Standards under TARP - the Rundown

When it comes to TARP (and by TARP I mean the EESA, and by the EESA I mean the ARRA), everyone’s talking about compensation limits. But there is a lot more to the new standards imposed on recipients of TARP funds by the recent legislation, and this is your one-stop, ten-minute guide.


TARP is the Troubled Asset Relief Program, which was established under the Emergency Economic Stabilization Act of 2008 (EESA). The language of TARP was then slightly amended and finalized in the American Recovery and Reinvestment Act (ARRA), which was signed by President Obama on February 17, 2009.

You can access the full text of the ARRA
here, and the section on corporate governance and compensation limits - Division B, Title VII, Section 7001 - is at the very end. You can also access the full text of the EESA here.

What are the corporate governance requirements under TARP as amended?

All TARP recipient companies are required to establish and follow certain standards. Some are pretty non-controversial, while others might surprise you.

  • Unnecessary and Excessive Risks - Limits on incentives that encourage Senior Executive Officers (SEOs) to take “unnecessary and excessive risks that threaten the value” of the company while TARP funds are still owed.

  • Clawbacks - Recovery of any bonus paid out to a SEO or the next 20 most highly-compensated employees, if that bonus was “based on statements of earnings, revenues, gains, or other criteria that are later found to be materially inaccurate.”

  • Golden Parachutes - Prohibition on any golden parachute payment made to a SEO or the next 5 most highly-compensated employees paid out while TARP funds are still owed. “Golden parachute payment” is defined in the previous section as “any payment to a senior executive officer for departure from a company for any reason, except for payments for services performed or benefits accrued.”

  • Long Term Restricted Stock - Prohibition of any bonus or incentive compensation other than long-term restricted stock, provided that the stock does not fully vest while TARP funds are still owed, and is not greater than 1/3 of the receiving employee’s total annual compensation. This one is unique, however, because the amount of employees it applies to depends on how much in TARP funds the company has received. The number is a sliding scale between 1 and 20, but each level includes a clause that states “or such higher number as the Secretary may determine is in the public interest” - hence the numbers are just a minimum guideline.

  • Manipulation of Reported Earnings (or what I like to call the “duh” provision) - Prohibition of any compensation plan that would “encourage manipulation of the reported earnings” so as to increase compensation of any of employees.

  • Compensation Committees - Establishment of a Board Compensation Committee that is “comprised entirely of independent directors” and meets at least semi-annually. TARP recipients that are privately-held may have their Board of Directors stand in for the independent compensation committee.

  • Luxury Expenditures - Establishment of a “company-wide policy regarding excessive or luxury expenditures” such as “entertainment or events; office and facility renovations; aviation or other transportation services.” (See Bank of America, Northern Trust, Merrill Lynch, the Auto CEOs, et al. I think we’re all pretty familiar with why this section was necessary.)

  • Certification of Compliance - The CEO and CFO of each TARP recipient has to file a certification of compliance; if the company is publicly traded, the compliance certification goes with the annual SEC filings. As those of us who have taken Securities Regulation know, certifying compliance can be a painstaking and risk-laden process, but that’s why you keep attorneys around.

Now here are some of the more interesting requirements:

  • Say-on-Pay - All TARP recipients must institute a say-on-pay policy. A say-on-pay provision is a non-binding advisory vote by shareholders on executive compensation plans as disclosed in the CD&A section of SEC filings. Boards do not have to follow the results of the shareholder vote, but are strongly encouraged to do so. Say-on-pay has had some momentum in recent years, mostly from institutional investors, but this is the first time the practice has been mandated in any way.

  • Retroactive Review of Executive Compensation - The Treasury must review all “bonuses, retention awards, and other compensation” paid out to SEOs and the next 20 most highly-compensated employees for each TARP recipient to “determine whether such payments were inconsistent with” the purposes of TARP or contrary to the public interest. If the Treasury finds inconsistency, they will negotiate appropriate reimbursement to the federal government. Okay, but here’s the catch - while most people are assuming that the Treasury is only going to be reviewing 2008 and 2009 bonuses, there is no actual time limit to retroactivity set out in the legislation. While a recipient could argue that bonuses paid out before 2008 were irrelevant to the current economic crisis or to the compensation limits in the legislation, the Treasury still retains the right to review any compensation practices for the applicable employees going back in time indefinitely.

  • Repayment - This section was added to the legislation after opponents of Barney Frank’s amendments (say-on-pay) argued that we were getting ahead of ourselves in oversight. Therefore, TARP recipients reserve the right to repay TARP funds “without regard to whether [they have] replaced such funds from any other source.” Also, the Treasury must liquidate warrants associated with the recipient’s funds at the current market price. While understandable that the emphasis here is on repayment, this provision has the potential to be incredibly dangerous.

So what now?

Look for more discussion on say-on-pay initiatives. Say-on-pay is a very effective way for boards to give the appearance of relinquishing control over executive compensation while not really being bound to the shareholders’ decision. But it also carries the power to make boards accountable by highlighting situations when they choose to override shareholders’ decisions, and perhaps pay the consequences with a proxy fight.

Also, it will be interesting to see the how the final section on repayment plays out. I know we’re getting ahead of ourselves discussing repayment already, but the fact that TARP recipients themselves have the power to decide how and when repayment takes place puts the spotlight squarely on the corporate boards who are seen as having created the mess in the first place.