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New Restrictions on Executive Compensation for Financial Institutions

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NEWS & INSIGHTS
Publications
9 FEB 2009

The Global Financial Crisis: Latest Responses by the US Government New Restrictions on Executive Compensation for Financial Institutions
CORPORATE AND SECURITIES ALERT

Altering limitations and requirements set out last fall, on February 4 President Barack Obama and Treasury Secretary Timothy Geithner announced new restrictions on executive compensation for institutions that receive financial assistance from the federal government. The same day, pending the issuance of formal regulatory guidance (expected in the near future), the Treasury Department issued a press release outlining the new rules. These rules cover three main areas: compliance and certification requirements; additional conditions on executive compensation for future recipients of government assistance; and long-term reform initiatives. The Emergency Economic Stabilization Act of 2008 (EESA) and related guidance issued by the Treasury Department already imposed limitations on executive compensation for financial institutions participating in the Capital Purchase Program (CPP), the auction purchase program or the program for systemically significant failing institutions. The original rules for CPP participants included a required certification that compensation exclude incentives for senior executive officers to take unnecessary risks; the adoption of clawback policies that would recover incentive compensation paid based on financial inaccuracies; prohibitions on golden parachute payments to senior executives; and limitations on the deductibility of compensation under Section 162(m) of the Internal Revenue Code of 1986, as amended (the Code). Auction program participants were subject to a prohibition on new employment agreements providing for golden parachutes; limited deductibility of golden parachutes (in addition to a 20 percent excise tax on recipients of such payments); and limited deductibility under Code Section 162(m). Systemically significant failing institutions were subject to limitations similar to those of CPP participants as well as an additional prohibition on making any payments in the nature of compensation to senior executive officers upon severance from employment.

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DLA Piper | Publications | The Global Financial Crisis: Latest Responses by the US Gove... Page 2 of 3

Who Must Comply with the New Rules The new rules regarding compliance and certification requirements apply to all financial institutions that have previously received government financial assistance, or that will receive it in the future. The additional restrictions on executive compensation do not apply to companies that have already received government assistance, but will apply to new recipients of such assistance and, presumably, to currently participating financial institutions needing additional government assistance in the future. With respect to restrictions on executive compensation, the new guidelines differentiate between institutions that participate in a “generally available capital access program,” such as the CPP, and institutions that require “exceptional assistance;” i.e., amounts greater than allowed under a standard program and subject to separately negotiated agreements with the Treasury. Examples of recipients of exceptional assistance cited in the press release are AIG, Bank of America and Citigroup. Compliance and Certification Requirements The compliance and certification rules outlined by the Treasury Department require that the chief executive officers of all financial institutions receiving government assistance provide an initial certification--and re-certify annually--that their institutions have complied with executive compensation restrictions under the applicable statutes and any specific contractual limitations placed on executive compensation. The compensation committees of all companies receiving government assistance must also explain how their senior executive compensation arrangements will not encourage excessive risk taking by senior executives. Additional Conditions on Executive Compensation The additional restrictions applicable to future recipients of federal assistance depend on whether the financial institution receives exceptional assistance or participates in a generally available program, such as the CPP. Financial Institutions Receiving Exceptional Assistance The original rules limit recipients of exceptional assistance to taking a $500,000 tax deduction on executive compensation under Section 162(m) of the Code. The new rules limit the entire amount of cash compensation payable to senior executives to no more than $500,000 (subject to an exception for restricted stock, as described below). Any amount over $500,000 must be paid to a senior executive in the form of restricted stock, which will only vest and become payable at the time the government is repaid (including any dividends required based upon the recipient’s contract with the government) or after a specified period and upon the satisfaction of certain conditions, including the extent to which the company has met repayment terms, protected taxpayer interests or satisfied lending and liability standards. Financial institutions must disclose their senior executive compensation structure and the rationale for paying such compensation and submit to a non-binding “say on pay” shareholder resolution. The new rules expand the applicability of the currently mandated clawback provision which requires that, in cases of misconduct, incentive compensation must be repaid. The original rules require repayment by the top 5 senior executives of the institution. The new rules expand this to the top 25

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DLA Piper | Publications | The Global Financial Crisis: Latest Responses by the US Gove... Page 3 of 3

senior executives. Similarly, the new rules expand the prohibition on receiving any golden parachute payment (i.e., a payment greater than three times the executive’s average annual compensation over the five preceding taxable years) upon severance from employment. The original rules covered the top 5 senior executives; the new rules cover the top 10 senior executives, and the next 25 senior executives will not be able to receive a golden parachute payment that exceeds one year of annual compensation. Participating institutions will be required to (1) adopt a policy regarding expenditures for luxury items such as aircraft, office renovations, entertainment, holiday parties, conferences and events outside of normal business operations and (2) post the policy on their websites. Rules for Companies Participating in Generally Available Programs Future participants in generally available programs, such as the CPP, are also subject to a $500,000 overall limit on cash compensation (subject to the restricted stock exception), unless they obtain a waiver by providing full public disclosure of their executive compensation arrangements and, if requested, submitting to a non-binding “say on pay” shareholder resolution. Financial institutions must also review and disclose the ways their compensation practices will not encourage “excessive and unnecessary risk-taking” by senior executives and other employees, rather than providing such certification with respect to just the top 5 senior executive officers, as required under the original rules. Participating financial institutions will also be required to apply a clawback provision covering incentive compensation to their top 25 senior executives. The maximum amount of the golden parachute payment for the top 5 senior executives will be reduced to one year of compensation (from the previous three times limit). Financial institutions receiving generally available assistance will be subject to the same requirement to adopt and post a luxury policy as are recipients of exceptional assistance. Long-Term Reform Initiatives In its press release, Treasury indicates that it intends to coordinate with the Securities and Exchange Commission on efforts to require the compensation committees of all public financial institutions, whether or not they receive government assistance, to review and disclose the details of their executive compensation arrangements. The press release mentions other potential initiatives. Among them may be requiring top executives to hold their stock for several years and requiring non-binding “say on pay” shareholder resolutions. The Treasury Department also plans to host a conference on executive compensation reform and seek public comment and testimony for purposes of determining best practices related to the executive compensation arrangements of financial institutions. To contact our Financial Crisis Response Team, please visit this page.

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