On January 9, 2009, Barney Frank introduced H.R. 384, the TARP Reform and Accountability Act, to amend the TARP provisions of the Emergency Economic Stabilization Act of 2008.

As introduced, the Reform Act would: require quarterly reporting on the use of TARP funds, limit the ability to use TARP funds to acquire healthy institutions, require additional compensation limitations, and require Treasury to make TARP Capital available to smaller depository institutions, including Subchapter S corporations and mutuals.

It is important to remember that this is the initial legislation as proposed by Congressman Frank, and it may never become the law, or undergo significant revisions before it becomes the law.  At this point, the proposed legislation raises as many questions as it does propose changes.

A brief summary of the provisions of TARP Reform and Accountability Act follows.  Note: Some of the provisions contained in the Reform Act would apply to all institutions that have received assistance under TARP, while others are structured to only apply to those receiving assistance following the effectiveness of the Reform Act.  We have attempted to distinguish between these provisions below.  We believe it is also important to distinguish between modifications that are requirements versus merely where the Reform Act provides for additional authority for Treasury to act.  Finally, Section 105, as noted below, may effectively permit the TARP Capital program to be largely unchanged for all institutions.

Modifications to TARP and TARP Oversight

Section 101.  New Obligations for TARP Recipients.

Any institutions receiving assistance under TARP would be required to publicly report, on a quarterly basis, the institution’s use of the assistance.  Depository institutions would be required to use the funds in a manner so as to “advance the purposes of this Act to strengthen the soundness of the financial system and the availability of credit to the economy” and would need to examined at least annually for compliance with the Act (either in connection with a full-site examination, or separately).

The proposed legislation would prohibit TARP recipients from merging or otherwise acquiring other banks or branches unless the Treasury Secretary determines that: (a) such action will reduce risk to the taxpayer; or (b) that the transaction could have been consummated without the TARP Capital.

The proposed legislation would also permit the Treasury to allow depository institutions to repay the TARP Capital without regard to whether the institution had completed a Qualified Equity Offering.  This would effectively eliminate  the restrictions on redemption for the first three years.

Section 102. Executive Compensation and Corporate Governance

Recipients of new assistance following the effectiveness of the this legislation would be subject to additional executive compensation restrictions, including a prohibition on paying or accruing any bonus or incentive compensation for the 25 most highly-compensated employees.  Such recipients would also be obligated to sell or otherwise divest any interest in any private passenger aircraft.

The Reform Act provides authority for the Treasury to retroactively apply these executive compensation limits to institutions that have already received TARP assistance, but does not require the Treasury to do so.  (The Securities Purchase Agreement only permits Treasury to unilaterally amend the agreement if such amendment is “required to comply with any changes after the Signing Date in applicable federal statutes.”  A strong argument can be made that the Treasury’s authority to retroactively apply these executive compensation limits does not necessitate an amendment.  Therefore, these more extensive executive compensation limits should not be applied to  TARP Capital participants, and, due to Section 105, will also not apply to future TARP Capital infusions for financial institutions.)

The Treasury may require the attendance of an observer to attend board and committee meetings of all TARP recipients.  (It seems unlikely to us that Treasury will plan on sending observers to most community bank board meetings.)

Section 103.  New Lending Attributable to TARP

Call Reports would be amended so that institutions are required to report the amount of any increase in new lending in the period covered by such report (or the amount of any reduction in any decrease in new lending) that is attributable to TARP assistance.  While difficult to quantify, this would appear to permit an institution to compare the amount of new lending with TARP Capital with projections of new lending without TARP Capital.  If the institution cannot accurately quantify the effect of the TARP assistance, then the institution shall report the total amount of the increase in new lending.

Section 104.  Other Protections

The legislation would require that the Treasury receive warrants with a value equal to 15 percent of the aggregate amount of all assistance provided under TARP, and also otherwise modifies the types of warrants to be issued.  Due to Section 105, this would not affect the terms for financial institutions participating in the TARP Capital program.

Section 105. Availability of TARP Funds to Smaller Community Institutions

The legislation requires that the Treasury “promptly take all necessary actions” to make TARP funds available to smaller community financial institutions on terms comparable to the terms for financial institutions that received funding prior to the adoption of the Reform Act.  The legislation explicitly identifies institutions that have submitted applications but have not yet heard a response, S-corporations and mutually-owned insured depository institutions as needing comparable terms.

Section 106.  Increase in Size and Authority of Financial Stability Oversight Board

The oversight board would be expanded to include the Chairman of the FDIC and two additional members who are not currently federal employees.  The board would have the power to overturn policy decisions of the Treasury Secretary by a 2/3 vote.

Foreclosure Relief

Use of the second $350 billion is conditioned on the use of up to $100 billion (and no less than $40 billion) for foreclosure mitigation.  The Treasury would be required to submit a comprehensive plan to prevent and mitigate foreclosures on residential mortgages.

Confirmation of Authority for Auto Manufacturers and Other Uses

The Reform Act confirms Treasury’s authority to support the financing arms of automakers and the availability of consumer loans, and auto and other vehicle loans.

HOPE for Homeowners Improvements

The Reform Act contains a number of improvements to the HOPE for Homeowners program, including the elimination of the 3% upfront premium, a reduction in annual premiums, and raising LTV limits.

Home Buyer Stimulus

The Reform Act requires the Treasury to develop a program, outside of TARP, to stimulate demand for home purchases and clear inventory of properties.

Permanent Increase in Deposit Insurance

The Reform Act proposes to make the $250,000 deposit insurance limit permanent.  It is currently set to sunset back to $100,000 at December 31, 2009.  (The Reform Act does not extend the TLGP’s transaction account guarantee to provide unlimited deposit insurance for noninterest-bearing transaction accounts.)   The Reform Act does not extend the obligation of the FDIC to provide this increased insurance at no additional cost to depository institutions.

The Reform Act also gives the FDIC 8 years instead of 5 years to rebuild the reserve ratio (which should lower insurance assessments) but also gives the FDIC the authority to charge systemic risk special assessments on depository institutions and holding companies.