Posted on 06 Mar 2009
The massive economic stimulus bill signed into law by President Obama on February 17 contains a far-reaching set of new restrictions on executive pay at banks and other financial institutions.
The legislation targets pay for companies that receive financial assistance from the federal government under the Troubled Assets Relief Program (TARP), building on a narrower set of restrictions announced by the Treasury Department on February 4.
Many of the latest restrictions apply to "senior executive officers" (SEOs), defined as the five most highly compensated executives whose pay is subject to disclosure in a company's proxy materials. This will likely be defined as the same group to whom the current TARP restrictions apply — the CEO, CFO and next three most highly compensated officers.
Building on the Current TARP Rules for Executive Compensation
More specifically, the legislation imposes the following restrictions on TARP participants:
* It reiterates the TARP prohibition against incentives that would encourage SEOs to take unnecessary and excessive risks and prohibits any compensation plan (apparently for any employee) that would encourage manipulation of reported earnings.
* It expands the clawback requirement under the current TARP rules for compensation to cover SEOs and the next 20 most highly compensated employees.
* It limits the tax deduction for SEO pay to amounts at or below $500,000 per year, without any exemption for performance-based compensation.
* It prohibits any golden parachute payments to an SEO or any of the next five most highly compensated employees.
* It requires company boards to have a company-wide policy regarding excessive or luxury expenditures.
* It requires the CEO and the CFO to annually certify compliance with the law’s new pay restrictions.
Departures From the Current TARP Restrictions on Executive Pay
The legislation also moves beyond the current TARP pay restrictions in at least two notable respects:
1. It generally limits bonus pay for top executives at financial institutions to no more than one-third of total annual compensation. This means, for example, that an executive earning $1.8 million in total pay will not be allowed to receive a bonus in excess of $600,000.
The restriction applies to the most highly compensated executive at organizations that have received $25 million or less in aid and scales up in three more increments to apply to SEOs and the next 20 most highly compensated employees for organizations that have received at least $500 million in assistance.
An important exception is provided for long-term restricted stock. This is defined as stock that does not fully vest while TARP financial assistance remains outstanding. An exception is also provided for any bonus required to be paid pursuant to a written employment contract executed on or before February 11, 2009.
2. The legislation requires shareholders to have a nonbinding “say on pay” vote to approve the compensation of executives as reflected in the proxy materials. This applies to all TARP recipients.
Treasury Review of Executive Bonuses Under Way
The new law also authorizes the Treasury to conduct a retroactive review of any bonuses, retention awards or other compensation paid to any employee of an entity that received TARP assistance before the stimulus bill was enacted. The aim is to determine whether such payments were inconsistent with the purposes of the government assistance program or otherwise contrary to public policy. The Treasury will seek reimbursement from the employer and the affected employee for any payments found to violate this standard.
Widespread Controversy on Executive Pay Restrictions
Widespread controversy erupted after the scope of the new restrictions became known. Critics in the banking industry said the rules mark a drastic departure from typical compensation practices, in which companies reward senior executives far more in bonuses than in annual salary. This is often considered a “needed to play” feature of pay for performance and a vital ingredient for attracting and retaining top talent.
It remains to be seen how banks and other financial institutions will restructure their pay mix to accommodate the new pay restraints. Employers elsewhere, especially those that have similar reward programs emphasizing bonuses and variable pay, will also be watching to see the impact on the overall compensation market and related incentive programs.