Bailout Bill Targets Exec Pay, Kinda Sorta

Washington’s wrangling over legislation to bail out Wall Street has finally lurched toward its dramatic finish … and also put renewed investor outrage over executive compensation into sharp focus.

Whether the Emergency Economic Stabilization Act passed last week will actually revive America’s wheezing banking sector remains unclear. Most observers do say, however, that the provisions related to executive pay won’t pack much of a long-term punch.

Hodgson

Lawmakers hassled over executive compensation last week as they debated the fate of the bailout bill; liberals wanted caps on CEO pay for companies participating in the Treasury Department’s rescue, conservatives didn’t. But Paul Hodgson, senior research analyst at The Corporate Library, says the resulting legislation won’t do much because it “doesn't encourage long-term policy change on executive compensation.”

The bailout legislation empowers the Treasury Department to purchase financial institutions’ troubled assets, subject to certain conditions. In the original bill defeated by the House of Representatives on Sept. 29, two of those conditions were to give shareholders an advisory vote on CEO pay packages and limited rights to place director nominations in the proxy statement. Both provisions were dropped from the final bill approved last Friday.

Still, some strings remain attached. For participants in the direct purchase program, the bailout bill prohibits financial institutions from making “any golden parachute payment to its senior executive officer during the period that the [Treasury Department] holds an equity or debt position in the financial institution.” The bill also allows a financial institution to recoup “any bonus or incentive compensation paid to a senior executive officer based on statements of earnings, gains, or other criteria that are later proven to be materially inaccurate.”

A senior executive officer is defined as “an individual who is one of the top 5 highly paid executives of a public company, whose compensation is required to be disclosed pursuant to the Securities Exchange Act of 1934.

Lipshaw

While the executive compensation-related provisions may have been necessary to get the bill passed, says Suffolk University Law School associate professor Jeffrey Lipshaw, he calls them “political gloss and really trivial compared to the amounts at issue.”

Part of the problem is that the administration and Treasury Department “have had to resist provisions that would be too Draconian because of their desire to get financial institutions to consider participating in a program,” notes Mark Borges, a principal with compensation consulting firm Compensia.

“What made it in is all very short term,” adds Hodgson. Most of the provisions apply to companies only as long as the Treasury holds an equity stake in the firm.

“We’ll have to see what the Treasury comes up with in terms of guidelines or regulations to put meat on the bones.”

— Andrew Graw,

Executive Compensation Practice,

Lowenstein Sandler

Patrick McGurn, special counsel for RiskMetrics Group, says the limits on golden parachute payments and the clawback standard “are pretty significant changes.” The limit on golden parachutes for executives of companies that participate in the direct purchase program “is the broadest foray [Congress] has made in executive comp since the ban on executive loans in the Sarbanes-Oxley Act,” he says. McGurn also notes that the bailout bill’s clawback provision requires a lower standard than the fraud standard required under the clawback provision of SOX.

But Graef Crystal, an executive compensation expert and a former compensation consultant, disagrees. “All of this stuff is like lipstick on a pig,” he says. Crystal says the provisions are largely “barriers in the road—you can get around them.”

The jury is still out on another provision that provides for limits on compensation “that exclude incentives for senior executive officers of a financial institution to take unnecessary and excessive risks” that threaten the value of the firm while the Treasury Department holds an equity or debt position in the financial institution. Observers say it’s too soon to say what effect, if any, that will have.

Graw

“We’ll have to see what the Treasury comes up with in terms of guidelines or regulations to put meat on the bones,” says Andrew Graw, head of the executive compensation practice at law firm Lowenstein Sandler.

Golden Parachutes, Snipped

The bailout bill prohibits golden parachutes in new employment contracts with senior executives, but only at companies where the total value of their bad debts purchased by the government tops $300 million. However, Borges points out, “It only applies to the companies in the worst shape, it only applies prospectively to agreements entered into after the program is in effect, and it sunsets at end of 2009.”

911 BAILOUT

Summary of the “Emergency Economic Stabilization Act of 2008”

I. Stabilizing the Economy

The Emergency Economic Stabilization Act of 2008 (EESA) provides up to $700 billion to the Secretary of the Treasury to buy mortgages and other assets that are clogging the balance sheets of financial institutions and making it difficult for working families, small businesses, and other companies to access credit, which is vital to a strong and stable economy. EESA also establishes a program that would allow companies to insure their troubled assets.

II. Homeownership Preservation

EESA requires the Treasury to modify troubled loans – many the result of predatory lending practices – wherever possible to help American families keep their homes. It also directs other federal agencies to modify loans that they own or control. Finally, it improves the HOPE for Homeowners program by expanding eligibility and increasing the tools available to the Department of Housing and Urban Development to help more families keep their homes.

III. Taxpayer Protection

Taxpayers should not be expected to pay for Wall Street’s mistakes. The legislation requires companies that sell some of their bad assets to the government to provide warrants so that taxpayers will benefit from any future growth these companies may experience as a result of participation in this program. The legislation also requires the President to submit legislation that would cover any losses to taxpayers resulting from this program from financial institutions.

IV. No Windfalls for Executives

Executives who made bad decisions should not be allowed to dump their bad assets on the

government, and then walk away with millions of dollars in bonuses. In order to participate in this program, companies will lose certain tax benefits and, in some cases, must limit executive pay. In addition, the bill limits “golden parachutes” and requires that unearned bonuses be returned.

V. Strong Oversight

Rather than giving the Treasury all the funds at once, the legislation gives the Treasury $250 billion immediately, then requires the President to certify that additional funds are needed ($100 billion, then $350 billion subject to Congressional disapproval). The Treasury must report on the use of the funds and the progress in addressing the crisis. EESA also establishes an Oversight Board so that the Treasury cannot act in an arbitrary manner. It also establishes a special inspector general to protect against waste, fraud and abuse.

Source

Housing Committee: One-Page Summary of EESA (2008).

Companies that sell more than $300 million in assets via auction are also subject to additional taxes, including a 20 percent excise tax on golden parachute payments triggered by events other than retirement. (Golden parachutes will be honored in pre-existing employment contracts.) The bailout also limits corporate tax deductions on executive pay to covered executives in excess of $500,000. Section 162(m) of the Internal Revenue Code limits the deduction for pay over $1 million, excluding performance-based compensation.

John O’Neill, a partner at the Venable law firm and former policy director and counsel to Senate Republican Whip Trent Lott (R-Miss), notes that the deductibility limit applies for a broad group of employees—and once an employee is designated as covered, “they never get out.”

The cap also raises the tricky question of whether companies already sullied in the public eye will risk even more bad publicity by paying above the limit, O’Neill says.

Others say the tax code provisions are essentially toothless. A number of companies routinely pay executives compensation well beyond the current $1 million cap under Section 162(m), and many of the firms that participate in the rescue plan won’t post any profits to qualify for the deduction anyway, probably for years to come. The excise tax is also unlikely to have much effect, since most companies provide tax grossups to executives to cover Section 280G excise taxes.

Borges

Unless the Treasury Department forbids grossups in this case, applying the 20 percent excise tax to severance payments “will have some impact but I’m not sure it will have the impact they think it does,” Borges says.

More to Come

Still, observers say companies should stay tuned, since executive pay is certain to get another look from lawmakers after the election.

“Post-election day, we’ll see legislation making much broader changes than those suggested by this bill,” McGurn says. “This is just a prelude to a much larger, SOX Part II-type of legislation aimed at the broader corporate community that will do to the compensation process what SOX Part I did to the audit process.”

Likewise, Thomas McCord of the law firm Nixon Peabody says: “Whether they result in a bailout or not, we only need a few more examples of companies going under with the perception that executives have made a lot of money to spark the impetus for a new round of rulemaking.”

For instance, he says, the lower Section 162(m) deductibility cap could be extended beyond the companies participating in the rescue plan. “Having made the agreement here opens the door to the possibility of expanding the limit to apply to a broader group of companies,” he says.

McCord

McCord says an earlier proposal that would have tied senior executive compensation to some multiple of compensation paid to the lowest full-time employee could also re-emerge. While that proposal didn’t make it into the bill voted on by Congress, “The fact that it received serious discussion is enough to lead me to believe we might see something that would apply beyond the scope of this set of regulations.”