“Bailout Bill” Places Strict Limits on Executive Pay of Participating Financial Institutions

October 13, 2008

The Emergency Economic Stabilization Act of 2008 (the “Act”), which establishes the Troubled Assets Relief Program (“TARP”), imposes strict new limits on executive compensation, including limits on incentive and severance pay, on certain financial institutions that participate in TARP.

Requirements of the Act

If the Treasury Secretary (the “Secretary”) (i) purchases troubled assets directly from a financial institution subject to the Act, and (ii) the Secretary receives a "meaningful equity or debt position" in the financial institution, the institution must meet "appropriate standards" for executive compensation for "senior executive officers," based on the following criteria:

  • Exclusion of incentives to take "unnecessary and excessive risks that threaten the value of the financial institution" during the period the Secretary holds an equity or debt position in the financial institution;

  • Recovery by the financial institution of any bonus or incentive compensation paid based on statements of earnings, gains, or other criteria that are later proven to be materially inaccurate;

  • Prohibition on payment of any golden parachute payment during the period the Secretary holds an equity or debt position in the financial institution.

If the Secretary purchases troubled assets of a financial institution through an auction purchase and that purchase, combined with all other purchases (either at auction or directly from a financial institution), exceed an aggregate amount of $300,000,000, such financial institution shall be prohibited from entering into any new employment contract with a senior executive officer that provides a golden parachute payment in the event of an involuntary termination, bankruptcy filing, insolvency, or receivership. In addition, under substantially similar criteria as described in the prior sentence, there is a cap of $500,000 for any applicable year on the tax deduction available to the financial institution for compensation payable to each "covered executive" for services performed during that year and any "deferred deduction compensation" (essentially, deferred compensation) payable that year, and an overall tax deduction limit of $500,000 on all such deferred deduction compensation. Finally, any severance payments to a "covered executive" made upon an involuntary termination, or in connection with a bankruptcy, liquidation, or receivership of the financial institution shall be subject to a potential lost tax deduction and imposition of the 20% golden parachute excise tax on the executive, regardless of whether a change in control has occurred.

A "senior executive officer" or "covered executive" is defined generally as one of the top 5 highly paid executives, whether in a public or non-public company.

Effective Date

There is no transitional relief provided under the Act. The financial institutions participating in TARP are generally subject to the restrictions on executive compensation immediately. These restrictions shall remain in effect for all financial institutions participating in TARP until December 31, 2009 (or if TARP is extended, until October 3, 2010), or, if later, until the date the Secretary no longer holds an equity or debt position in the financial institution.

Additional Guidance

The Act provides that the Secretary will issue additional guidance within two months from the date of enactment of the Act. Until then, financial institutions that intend to participate in TARP should begin reviewing their executive compensation plans and agreements to determine whether amendments will be necessary to comply with the requirements of the Act.

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