Posts filed under ‘EESA’
The President announced plans today that, if put into action, would lead to the realization of at least some much-needed and long-sought-after assistance for community banks. A copy of the President’s announcement is available here. (Skip to Page 2 for Details).
According to the President’s proposal, which is part of the White House’s “Financial Stability Plan,” the program would target small business lending, but would also offer a mechanism for banks with less than $1 billion in assets to access capital with an annual dividend rate of 3%. The announcement is short on specifics, but here are the basics:
(1) Banks will receive capital in an amount equaling up to 2% of risk-weighted assets;
(2) The annual dividends on the capital will equal 3% for the first five years and 9% thereafter; and
(3) Banks seeking to participate in the program will submit a “small business lending plan” in which the bank explains how additional capital will help increase its lending to small businesses. (Banks approved for the program that elect to participate will also be required to follow up with quarterly reports detailing small business activities).
Over the next few weeks, Treasury will work with community banks and the small business community to hammer out the program’s specifics. Notably, the release contemplates that banks already participating in the capital purchase program will be able to replace existing capital, which carries a 5% dividend (7.7% for S-Corps), with investments under the new program.
The President also announced support for legislation that would increase the size of key Small Business Administration (SBA) loans. The aim of the increase would (supposedly) allow the SBA to ensure that more small businesses can get access to credit.
The first prong of the proposed legislation would increase the Maximum 7(a) loan from $2 million to $5 million, providing greater access to capital that businesses could use to boost working capital as well as purchase machinery equipment and real estate.
The second prong of the proposed legislation would increase the maximum 504 project loan from $2 million to $5 million for standard borrowers (supporting a total project of $12.5 million) and from $4 million to $5.5 million for manufacturers (supporting a total project of $13.75 million), thereby increasing the qualifying borrowers’ ability to undertake larger projects.
And the third prong of the proposed legislation would increase the maximum loan size of the SBA microloan programs from $35,000 to $50,000.
Overview. The U.S. Department of the Treasury (Treasury) has issued an interim final rule (New Compensation Restriction Rules) implementing the executive compensation provisions of the Emergency Economic Stabilization Act of 2008 (EESA). The New Compensation Restriction Rules apply to the senior executive officers of any financial institution participating in any part of the Treasury’s Troubled Assets Relief Program (TARP), including, the Capital Purchase Program (CPP), the Program for Systemically Significant Failing Institutions (PSSFI) and the Troubled Asset Auction Program (TAAP). Although the extent of the Compensation Rules’ impact will depend upon the program in which a particular financial institution chooses to participate, most institutions (even private ones) will be required to comply with one or more of the following rules:
- Ensure that incentive compensation for senior executives does not encourage unnecessary and excessive risks;
- Recover any bonus or incentive compensation paid to a senior executive based on statements of earnings, gains or other criteria that prove to be materially inaccurate;
- Refuse to make any golden parachute payment to a senior executive officer during the period that the Secretary holds an equity or debt position in the institution;
- Forego federal income tax deductions on executive compensation exceeding $500,000 in a given tax year. Note: not a restriction on compensation levels, but on deductibility; and
- Senior executives covered by the New Compensation Restriction Rules include the chief executive officer, chief financial officer and the three other most highly compensated executive officers (SEOs).
When do these new rules apply? The applicability of the New Compensation Restriction Rules depends upon several factors, including the value of the assets sold by the institution to the Treasury and the method by which the Treasury acquires those assets (directly or via auction). Consider the following:
- The Compensation Restriction Rules apply to every financial institution along with its control group parent or subsidiaries (Subject Entity) that (a) participates in CPP, (b) sells more than $300 million of assets via the TAAP or (c) becomes part of the PSSFI.
- For participants in the CPP, the New Compensation Restriction Rules apply only during the time period that the Treasury holds an equity or debt position in the financial institution. For participants in the TAAP, the New Compensation Restriction Rules apply at least through December 31, 2009 and possibly through October 3, 2010, depending on whether Treasury extends the program.
- The New Compensation Restriction Rules apply only to SEOs. To implement this requirement, the New Compensation Restriction Rules look to Item 402 of Regulation S-K, applied under federal securities laws in connection with public offerings and public company periodic reporting. The Item 402-based determination of SEOs applies whether the institution is public or private.
Item 402 states that executive officers (other than the CEO or CFO) must make at least $100,000 and the determination as to which executive officers are the most highly compensated shall be made by reference to total compensation for the last completed fiscal year. However, the New Compensation Restriction Rules require Subject Entities to use “best efforts” to determine the three most highly compensated executive officers prior to having year-end compensation data for the current year. Also, Item 402 states that executive officers may include one or more executive officers or other employees of subsidiaries. Under limited circumstances, a Subject Entity may exclude an individual, other than its CEO or CFO, who is otherwise one of the most highly compensated executive officers, due to the payment of amounts of cash compensation relating to overseas assignments attributed predominantly to such assignments.
Restrictions By Specific TARP Program. As noted above, the effect that the New Compensation Restriction Rules will have on a given financial institution will depend upon which TARP program the institution chooses. The following paragraphs explain in greater detail the compensation restrictions associated with a given TARP program.
- Capital Purchase Program – This program allows the Secretary to purchase assets directly from financial institutions in exchange for a meaningful debt or equity position in the institution. The New Compensation Restriction Rules place several compliance requirements on financial institutions participating in the CPP.
First, the institution’s compensation committee, in conjunction with the institution’s senior risk officers, must ensure that SEO compensation packages do not prescribe incentive compensation that promotes unnecessary and excessive risks. The first such review must be completed within 90 days of the institution’s initial participation in the CPP, and a similar review must occur annually (but only while the Secretary holds a debt or equity interest in the institution pursuant to CPP). After these reviews, the compensation committee must certify that the reviews have been completed. Note the rules provide no guidance, other than consultation with risk management officers, as to what constitutes risk-promoting compensation. And, although the rules require the compensation committee to certify that SEO contracts comply with the prohibition on risky compensation pay, the certification will not be provided until after the Treasury has purchased troubled assets from the Subject Entity. The New Compensation Restriction Rules are not clear on what would happen if an existing contract did not comply with the Secretary’s guidelines.
Second, any financial institution participating in the CPP must require SEOs to repay any bonus or incentive compensation previously received if such compensation was based on statements of earnings, gains or other criteria that prove to be materially inaccurate. Note, although similar in many respects to Section 304 of Sarbanes-Oxley, this provision is in reality much broader. This provision applies to both public and private institutions, is not triggered exclusively by an accounting restatement, has an unlimited recovery period and covers not only material inaccuracies in financial reporting, but also material inaccuracies relating to other performance metrics used to award bonuses and incentive compensation.
Third, a financial institution cannot make any golden parachute payments to any SEOs while the Secretary holds an equity or debt position acquired under the CPP. For purposes of this rule, the term “golden parachute” payment refers to any compensation, other than a payment under a qualified retirement plan, with an aggregate present value that equals or exceeds 300% of the employee’s base salary. While that definition is similar to the term “excess parachute” payment set forth in § 280G of the Internal Revenue Code, “golden parachute” payments subject to EESA include all payments triggered by an applicable severance from employment, regardless of whether there has been a change in control of the financial institution, and encompass most any compensation paid on account of an SEO’s involuntary termination from employment, including terminations associated with the institution’s bankruptcy, insolvency or receivership.
Fourth, the financial institution must agree to forego any federal income tax deduction on the compensation in excess of $500,000 paid to any SEO.
- Programs for Systemically Significant Failing Institutions – Under this program, the Treasury provides direct assistance to certain failing financial institutions on terms negotiated on a case-by-case basis. These standards are similar in all respects to the New Compensation Restriction Rules applicable to the CPP, except that the definition of “golden parachute payment” is defined even more broadly. Like the CPP program discussed above, a financial institution participating in the PSSFI must prohibit any golden parachute payment to a SEO while the Treasury holds a meaningful equity or debt position in the institution. But unlike the CPP, for purposes of PSSFI, a “golden parachute payment” is defined as any compensatory payment to an SEO on account of severance from employment (i.e., not just payments in excess of 300% of the SEO’s base amount).
- Troubled Asset Auction Program – Under this program, the Treasury purchases troubled assets from a financial institution through an auction format. As prescribed by EESA, any financial institution that sells more than $300 million of troubled assets to the Treasury via auction would be prohibited from entering into new executive employment contracts that would provide a golden parachute payment to an SEO in the event of the SEO’s involuntary termination, or in connection with the financial institution’s bankruptcy filing, insolvency or receivership. The employment agreements subject to this rule will be considered “new” agreements if entered into on or after the date the financial institution has sold at least $300 million in troubled assets under TARP, provided that some of the asset sales were conducted through TAAP. An employment agreement that is renewed or materially modified after such date is also considered a “new” arrangement for this purpose. In addition, EESA precludes any financial institution from receiving any federal income tax deduction for any compensation in excess of $500,000 paid to an SEO.
On October 3, 2008, the President signed into law the Emergency Economic Stabilization Act of 2008 (“EESA”). EESA is an attempt by Congress to restore liquidity and stability to the United States financial system by, among other things, authorizing the Secretary of the Treasury to purchase or guarantee payment of troubled assets currently held by financial institutions.
On October 1, 2008, in a stated attempt to restore liquidity and stability to the United States’ financial system and in light of the United States House’s failure to pass a similar bill on Monday, the United States Senate proposed the latest version of the bailout bill (“Stabilization Bill”). The Senate version is very similar to the House version, but two major changes include:
- Raising the FDIC insurance amount on FDIC insured deposits to $250,000 from $100,000.
- Removing any cap on the FDIC borrowings from the Treasury until the end of 2009. Prior limit was $30 billion, which will reinstate in 2010 unless other action is taken.
If enacted into law, the Stabilization Bill would be called the Emergency Economic Stabilization Act (the “Act”). This version of the Stabilization Bill is otherwise very similar to the House version but yet significantly more detailed than the version proposed last week. This version of the bill attempts to address some of the earlier concerns expressed by commentators and citizens by limiting the discretion granted to the Secretary of the Treasury (the “Secretary”) and providing more oversight, as well as an insurance component. However, the bill still does not suspend mark-to-market rules or provide a lending v. purchase program.
If you would like more information about this, we will be following this matter closely.
Below is a summary of the other material provisions of the Stabilization Bill:
- Amount – Cap of $700 billion for buying troubled assets. Breakdown:
- $250 billion available to Secretary on Day 1.
- An additional $100 billion if the President submits a written certification to Congress that the Secretary needs additional funds.
- The remaining $350 billion is available if the President submits to Congress a written certification that the Secretary needs additional funds and a written report detailing the Secretary’s plan to exercise the Secretary’s authority under the Act and Congress does not pass a joint resolution within 15 days of the report’s submission disapproving the increase.
- New Guarantee/Insurance Piece - Complementing this new purchase program, the Stabilization Bill will require the Secretary to establish a guarantee program available to all troubled assets originated or issued prior to 3/14/2008. Under this program:
- The United States government will guarantee timely payment of principal and interest due on the troubled assets rather than purchasing them outright.
- The Secretary must determine the long-term viability of the affected financial institution and direct purchases and guarantees toward the most efficient use of funds.
- All financial institutions may participate in the guarantee program – no discrimination based on size, location, or type, size or number of troubled assets.
- Financial institutions must pay a premium to participate. These premiums may vary based on the credit risk of the particular troubled asset being guaranteed.
- The insurance program does not have separate funding; it is funded by (a) premiums and (b) a reserve from the funds that would otherwise be available to purchase troubled assets under the purchase program.
- Financial assistance is available, but only if (a) the financial institution was adequately capitalized on June 30, 2008, (b) the financial institution has assets less than $1 billion, (c) the financial institution’s capitalization level dropped one or more levels because devaluation of preferred government sponsored enterprises stock, and (d) assistance can be provided in manner sufficient to at least restore adequate capitalization levels.
- Troubled Assets – The Stabilization Bill defines troubled assets as those the Secretary determines that the purchase of provides stability and which fall into one of the two following categories:
- Residential and commercial mortgages originated or issued on or before 3/14/08 and any securities, obligations and other instruments based on or related to such mortgages; and
- Other instruments identified by the Secretary after consultation with Chairman of the Board of Governors of the Federal Reserve, if such determination is reported, in writing, to the appropriate Congressional committees.
- No Unjust Enrichment - Under the Stabilization Bill, the Secretary may not act in such a way as to promote unjust enrichment. This includes purchasing troubled assets at a higher price than what the seller paid. This limitation does not apply to troubled assets acquired in a merger or acquisition or from a financial institution that has initiated bankruptcy proceedings under title 11 of the United States Code or is in conservatorship or receivership. Moreover, any guarantee issued by the Secretary cannot be higher than 100% of the principal and interest payments due.
- Oversight -
- Office of Financial Stability formed under Office of Domestic Finance of the Department of Treasury.
- Financial Stability Oversight Board will be formed and consist of the Chairman of the Board of Governors of the Federal Reserve System, the Secretary, the Director of the Federal Home Finance Agency, the Chairman of the Securities and Exchange Commission, and the Secretary of Housing and Urban Development.
- The bill calls for the Secretary to “take into consideration” nine factors, including serving the underserved, protecting families, saving money, ensuring stability, and protecting taxpayers.
- Contractors – The Secretary will have the power to hire, fire, and contract with servicers, liquidators, attorneys, etc.
- General Authority -
- As in the original bill, the Secretary is authorized to purchase, work out and liquidate troubled assets on terms and conditions determined by the Secretary subject to the Act and policies and procedures developed by the Secretary.
- New to this draft of the bill, the Secretary must issue regulations to “establish vehicles” to hold troubled assets.
- In many cases, the Secretary has discretion as to how to proceed as long as he consults with various agencies.
- Conflicts of Interest – The Secretary must set conflict of interest regulations.
- Executive Compensation – The Secretary must establish regulations to prevent clawbacks and golden parachutes for executives.
- Judicial Review – Judicial review is based on judicial review under the Administrative Procedure Act (“APA”), though the statute doesn’t direct the review to the courts of appeals as it does for APA rulemakings. The powers given the Secretary under section 101 are not subject to injunctive or equitable relief, and yet the statute carefully limits injunctive relief in some cases. Currently:
- “Actions by the Secretary pursuant to the authority of this Act shall be subject to chapter 7 of title 5, United States Code, including that such actions shall be held unlawful and set aside if found to be arbitrary, capricious, an abuse of discretion, or not in accordance with law.”
- But “No injunction or other form of equitable relief shall be issued against the Secretary for actions pursuant to section 101 . . . other than to remedy a violation of the Constitution.”