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Article published in
Agenda, April 27, 2009
Opinion: Boards Must Prep for Spread of TARP Comp Rules
By Jim Barrall
U.S. public companies are caught in a violent storm over executive
compensation practices. The more than 500 financial institutions that have
accepted aid under the Troubled Asset Relief Program and related programs
(broadly called TARP) are being pummeled on every front, including by everchanging and ever more intrusive executive compensation rules. Further, it’s
becoming increasingly clear that the regulatory backlash won’t be confined
to TARP recipients.
“Public companies that are not
receiving federal aid should realize
that the TARP recipients are
just canaries in the coal mine.”
Jim Barrall, partner, Latham & Watkins
Last October, the TARP limitations emerged as relatively benign corporate
governance and tax rules. The policies targeted the taxability of golden
parachute payments and compensation in excess of $500,000 for the five
most highly compensated company officers. However, after a succession of
bailout waves, these rules now flatly prohibit any parachute payments, any
bonuses not paid in restricted stock, any bonuses greater than 50% of
salary, and any cash compensation in excess of $500,000 for larger groups
of top employees. Further, TARP recipients have agreed to accept yet
unknown additional limits in the future and are expected to renegotiate
existing agreements. Finally, in a populist fit triggered by American
International Group’s payment of contractual bonuses, the House passed
retroactive legislation that would impose retaliatory income taxes on
bonuses paid by TARP recipients; a similar bill is pending in the Senate.
Public companies that are not receiving federal aid should recognize that the
TARP recipients are just canaries in the coal mine. The government’s
regulation of executive compensation likely will broaden to cover all U.S.
publicly traded companies, survive and go beyond the TARP limits. As
evidence that the rules will spread, consider the following:
• Critics of U.S. pay practices, ranging from legislators to shareholder
activists, have been discussing similar approaches for years for all public
companies and are capitalizing on the moment.
• As the government needs to muster public support for additional bailout
funding, it’s recognizing that making piñatas of TARP recipients’ executive
compensation is bad public policy. They see that this approach could
diminish the recipients’ ability to repay their obligations and destroy their
global competitiveness. So given the need to assuage public anger in order
to raise more bailout funds, Congress is likely to direct its efforts to enact
broader executive compensation regulation.
• Many Americans, who have felt the pain of the recession in their 401(k)
plan accounts, are angry at compensation practices beyond those of the
financial sector.
Non-TARP companies likely will be spared TARP’s pay caps and most
intrusive governance restrictions, but it’s very likely that Congress will enact
a Say on Pay law (as proposed in the Senate by then Senator Barack Obama
and as passed by the House in 2007), which would require every U.S. public
company to submit its executive compensation policies to annual
shareholder approval. While companies would not be required to implement
these “advisory” votes, they would set the stage for powerful proxy advisory
firms to unseat directors and annually expand their lists of targeted
practices. The SEC is also likely to adopt shareholder proxy access rules that
will allow hedge funds and activists of all stripes to attack boards and run
their own slates. In addition, the SEC’s 2006 proxy rules are likely to be
amended to require even more disclosure of compensation practices. Finally,
the tax code likely will be used to target disfavored practices and raise
revenue.
So boards and compensation committees should act for the long-term good
of companies and their shareholders, as well as stay out of harm’s way in
these turbulent times, by:
• Judiciously using compensation that’s not performance-based (other than
salaries).
• Designing performance compensation that’s truly based on the company’s
business plans and aligned with shareholders’ interests.
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• Implementing programs that do not encourage excessive risk-taking by
using vesting schedules, holdbacks, clawbacks and equity holding
requirements.
• Planning for succession and avoiding the risks and expenses of filling
officer vacancies from the outside.
• Ensuring that compensation policies are persuasively explained to
shareholders.
• Opening direct dialogues with key shareholders and not abdicating this
important arena to the proxy advisory firms.
• Monitoring developments and not designing compensation based on past
practices.
• Understanding which new or continued practices could expose directors to
attack when adopting new plans or amending old ones.
With careful thought and planning, conscientious boards and companies
should be able to navigate this storm. Those who have not been paying
attention to which way the wind is blowing will likely pay the price.
Disclaimer: This article expresses the author’s views and does not
necessarily reflect those of Latham & Watkins.
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