February 25, 2009
Authored by: Robert Klingler
On February 17, 2009, President Obama signed into law the American Recovery and Reinvestment Act of 2009 (the “Act”), previously just called the economic stimulus bill. Both the complete legislation and the provisions directly related to executive compensation can now be found online. Furthermore, we have previously posted our summaries of the executive compensation provisions and the tax provisions most likely to impact community banks.
Below, we have summarized the new TARP Capital closing documents, Senator Dodd’s Letter on the Act, the effectiveness date for the provisions of the Act, the SEC’s guidance on the Act, and remaining open questions.
In light of the new executive compensation restrictions, the Treasury has modified the Waiver required to be signed in order to close TARP Capital investments, as well as added a side letter that addresses the modifications introduced by the Act.
The new Waiver (i) acts as a consent to all modifications required to comply with the TARP Capital restrictions; (ii) requires repayment to the company by employees of any payments made in violation of the TARP Capital restrictions; and (iii) expands the TARP Capital restrictions to include the Emergency Economic Stabilization Act, as amended (EESA), and all rules, regulations, guidance or other requirements issued under EESA, rather than just compliance with the regulations adopted by the Treasury on October 20, 2008. As noted below, the Waiver now must be signed by the company’s senior executive officers as well by any additional highly compensated employees “required by applicable rules or regulations.” We have uploaded a marked version of the Waiver showing the modifications.
The new side letter confirms that the law trumps any contractual arrangements. Therefore, notwithstanding anything in the form documents to the contrary, to the extent the Act is inconsistent with the terms of the form documents, the Act shall control. The letter goes on to specify that (i) the executive compensation provisions of the Act shall apply to the company; (ii) the Waiver noted above needs to also be delivered by any additional highly compensated employees “required by applicable rules or regulations”; and (iii) the company’s chief executive officer and chief financial officer shall provide written certifications of compliance in accordance with the provisions of the Act. We have uploaded a clean version of the new side letter.
Notably absent from the side letter is an explicit acknowledgment that the company shall be permitted to repay the preferred shares after consultation with the appropriate federal banking agency without regard to whether the institution has replaced the funds, and that when such preferred shares are repaid, the Treasury will liquidate the warrants associated with such preferred shares “at the current market price,” both as required by the Act. We understand that a provision acknowledging these requirements was included in the side letter executed by companies that closed TARP Capital investments on February 20, 2009, but has since been struck by the Treasury. Although not specifically mentioned by the side letter, these provisions of the Act should also supersede the terms of the Securities Purchase Agreement.
On February 20, 2009, Senator Christopher Dodd, the Chairman of the Senate Banking Committee and the principal author of the executive compensation provisions contained in the Act, sent a letter to the Chairman of the SEC, Mary Schapiro, providing his interpretation of the provisions. Although certainly not binding, given the lack of other authoritative guidance, Senator Dodd’s interpretations are likely to carry some weight. Senator Dodd asks the SEC to give guidance “to public companies” for complying with the shareholder approval and certification requirements “as soon as practicable.”
As amended by the Act, Section 111(e)(1) of EESA requires annual shareholder approval of executive compensation. “Any proxy or consent or authorization for an annual or other meeting of the shareholders of any TARP recipient during the period in which any obligation arising from financial assistance provided under the TARP remains outstanding shall permit a separate shareholder vote to approve the compensation of executives, as disclosed pursuant to the compensation disclosure rules of the Commission (which disclosure shall include the compensation discussing and analysis, the compensation tables, and any related material).” Such a vote is typically characterized as giving shareholders a “say-on-pay.”
Senator Dodd is of the opinion that these requirements do not apply to preliminary proxy statements (and the related definitive proxy, even if filed after February 17) or definitive proxy statements filed with the SEC on or before February 17, 2009 (when President Obama signed the legislation), but does apply to proxies filed after February 17, 2009, regardless of when the SEC provides further guidance. Senator Dodd claims that the statute does not change the substantive disclosure requirements under SEC rules.
As amended by the Act, Section 111(b)(4) of EESA requires annual certification of compliance to the SEC, for public companies, and to the Treasury, for private companies. Because these certifications relate to compliance with executive compensation and corporate governance standards that have yet to be established by the Treasury, Senator Dodd is of the opinion that this requirement will not be effective until the Treasury establishes such standards.
While Senator Dodd is now requesting SEC guidance “as soon as practicable,” the compensation provisions of the Act (for which Senator Dodd was the primary architect) gives the SEC up to one year to issue final rules and regulations to implement “say-on-pay.” Similarly, Section 111(h) of the act requires the Treasury Secretary to adopt regulations to “implement” all of Section 111.
As addressed by Senator Dodd, the effectiveness of the provisions of the Act are subject to interpretation. While, Section 111(h) provides that the Treasury Secretary shall adopt regulations to “implement” all of Section 111, some of the regulations appear virtually self-executing.
The provisions related to the establishment of an independent compensation committee that meets at least semiannually (Section 111(c)) and the requirement to adopt a company-wide policy regarding excessive or luxury expenditures (Section 111(d)) may operate without further Treasury regulation (although these provisions are certainly subject to clarification by the Treasury).
Implementation of the American Recovery and Reinvestment Act’s requirement that a TARP Recipient be permitted (subject to consultation with the appropriate federal banking agency) to repay any TARP assistance without regard to whether the financial institution has replaced the funds from another source does not appear to be subject to further substantive limitation by the Treasury. However, the Treasury may seek to delay such repayment until it can adopt regulations providing a procedure for companies to follow, presumably not requiring a significant delay.
On the other hand, the provisions related to executive compensation and corporate governance established under Section 111(b) of EESA are clearly subject to the Treasury establishing standards. While the Act provides a minimum set of standards, even those standards are not technically in place until the Treasury implements regulations. However, the standards do serve as a guide as to where the restrictions will be. Specifically, the provisions outlined in Section 111(b)(3) include: (A) limits on compensation that encourage unnecessary and excessive risks; (B) recovery of bonuses based on materially inaccurate information; (C) the prohibition on golden parachute payments; (D) the staggered prohibition on paying or accruing bonuses; and (E) the prohibition on compensation plans that encourage manipulation of reported earnings.
Section 111(b)(4), which requires certification of compliance with the Treasury’s standards, would also appear to require that Treasury actually establish those standards. Similarly, and as noted above, the “say-on-pay” provisions call for the SEC to issue final regulations by February 17, 2010.
On February 24, 2009, the SEC issued its first set of Compliance and Disclosure Interpretations under the American Recovery and Reinvestment Act of 2009. The SEC has not provided its own separate interpretation of when the “say-on-pay” provisions are effective, but does explicitly acknowledge Senator Dodd’s position that February 17, 2009 is the relevant date.
The SEC Guidance clarifies that:
1. No separate shareholder vote on executive compensation is required for any meeting other than the annual meeting of shareholders for which proxies will be solicited for the election of directors or a special meeting held in lieu of such annual meeting.
2. Smaller reporting companies subject to the Act’s “say-on-pay” provision continue to not be required to provide Compensation Discussion and Analysis under Item 402 of Regulation S-K.
The statute says the disclosure shall include compensation disclosure and analysis, but SEC regulations currently permit smaller reporting companies to exclude such information. The SEC’s guidance provides that the disclosure obligations for smaller reporting companies are not changed by the Act, which is consistent with Senator Dodd’s letter to the SEC.
The SEC’s analysis for smaller reporting companies may also be informative of the SEC’s position vis-a-vis private TARP Capital recipients. To the extent the Act does not modify the disclosure requirements of companies, it may also not require private companies to comply with proxy rules that are only in effect for public companies.
3. Company proposals to have shareholders approve executive compensation will be required to file a preliminary proxy statement pursuant to Exchange Act Rule 14a-6. A company that would like to request an accelerated review should contact the Assistant Director of the SEC office that reviews the company’s filings to discuss the special circumstances faced by the company.
All SEC reporting TARP Capital recipients need to review their proxy season timetables to factor in this 10 day review period. The SEC’s review may expand to cover executive compensation and compensation discussion and analysis generally, and thus may ultimately take much longer than 10 days.
Like the SEC did for proxy statements to approve blank check preferred to participate in the Capital Purchase Program, the SEC will likely provide additional commentary on what it expects to see in proxy statements. Unfortunately, several banks will likely have to act as guinea pigs for the SEC before this guidance is provided.
In no particular order:
- Do companies have to provide a “say-on-pay” vote for their rapidly approaching annual meetings? Senator Dodd certainly thinks so, and the statute appears to require it immediately. However, the statute does provide “as disclosed pursuant to” the SEC’s rules, so perhaps the SEC will take a more limited approach. Similarly, the statute merely provides that TARP recipients have to “permit” a separate shareholder vote; the SEC (and companies pending SEC guidance) may interpret the statute as requiring a vote only if requested by a shareholder.
- Does “say-on-pay” apply to private companies as well? The statute appears to require disclosures in accordance with SEC rules (which would be non-applicable to private companies), but nominally applies to “any TARP recipient.”
- If private companies have to provide a non-binding shareholder vote on compensation, do they also have to provide disclosures about executive compensation? Senator Dodd appears to believe that the intent of the statute was not to change existing compensation disclosure requirements.
- Does the Act’s requirement for the Treasury Secretary to liquidate warrants “at the current market price” override the contractual provision that permits a TARP recipient to repurchase the warrant “at the Fair Market Value?” The Securities Purchase Agreement provides for a detailed process to determine the Fair Market Value of the warrant, while the Act now appears to contemplate simply liquidating the warrants based on current market price without consideration of the remaining warrant term. Similarly, does the Act convert the repurchase of the warrant from a company right to a company obligation?
- Who needs to sign the Waiver until the Treasury implements regulations under Section 111, as amended by the American Recovery and Reinvestment Act? Presumably the existing regulations are still in place, while the new provisions affecting other highly compensation executives are not, so only the senior executive officers would currently need to sign.
- Do the existing regulations, including the Interim final rule adopted on January 16, 2009, still apply? Will they? The authority for those regulations has been amended in its entirety by the American Recovery and Reinvestment Act, but these regulations presumably remain operative until and unless ruled otherwise by the Treasury or a federal court. Presumably, the Treasury will ultimately align the regulations with the new statutory provisions to clarify when and how frequently the compensation committee needs to meet and when and to whom certifications need to be made.
- How does a company calculate the employees subject to the Act’s restrictions? The senior executive officers and the next 20 “most highly-compensated employees” are subject to the clawback provisions; the senior executive officers and the next five “most highly-compensated employees” are subject to the prohibition on golden parachute payments; while a sliding scale between the “most highly-compensated employee” and the senior executive officers and the next 20 “most highly-compensated employees” are subject to the bonus restrictions. Are subisidary bank employees included, or only holding company employees? Do you use the prior year’s compensation (in which case the most highly-compensated will likely change year-to-year)? Do you use actual compensation (in which case other employees may ultimate be more highly compensated than the “most highly-compensated employees)?