The Bailout and Corporate Governance

Congressional negotiators apparently worked hard over the weekend to finish the bailout legislation.  A draft is posted on the House Financial Services Committee web site along with a section by section analysis.  The draft bill retains limits on executive compensation but no longer contains the provisions in the original House bill that would require access and a vote on say on pay.  

In the case of companies where Treasury makes a direct purchase of assets and, as a result, has a "meaningful" equity position,  the companies must meet  "appropriate standards for executive compensation and corporate governance."  Despite the mention of corporate governance, in fact the requirements all relate to executive compensation.  It requires the exclusion of incentives for taking excessive risks, a clawback provision for incentive compensation based on criteria "later proven to be materially inaccurate."  During the period when the government holds a debt or equity position, golden parachute payments are prohibited. 

Specifically, Section 111, titled "executive compensation and corporate governance," provides:

• (a) APPLICABILITY.—Any financial institution that sells troubled assets to the Secretary under this Act shall be subject to the executive compensation requirements of subsections (b) and (c) and the provisions under the Internal Revenue Code of 1986, as provided under the amendment by section 302, as applicable.

• (b) DIRECT PURCHASES.— 

• (1) IN GENERAL.—Where the Secretary determines that the purposes of this Act are best met through direct purchases of troubled assets from an individual financial institution where no bidding process or market prices are available, and the Secretary receives a meaningful equity or debt position in the financial institution as a result of the transaction, the Secretary shall require that the financial institution meet appropriate standards for executive compensation and corporate governance. The standards required under this subsection shall be effective for the duration of the period that the Secretary holds an equity or debt position in the financial institution.

• (2) CRITERIA.—The standards required under this subsection shall include— (A) limits on compensation that exclude incentives for executive officers of a financial institution to take unnecessary and excessive risks that threaten the value of the financial institution during the period that the Secretary holds an equity or debt position in the financial institution; (B) a provision for the recovery by the financial institution of 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; and (C) a prohibition on the financial institution making any golden parachute payment to its senior executive officer during the period that the Secretary holds an equity or debt position in the financial institution.

• (3) DEFINITION.—For purposes of this section, the term ‘‘senior executive officer’’ means an individual who is one of the top 5 executives of a public company, whose compensated is required to be disclosed pursuant to the Securities Exchange Act of 1934, and any regulations issued thereunder, and non-public company counterparts.
  

• (c) AUCTION PURCHASES.—Where the Secretary determines that the purposes of this Act are best met through auction purchases of troubled assets, and only where such purchases per financial institution, in the aggregate exceed $300,000,000 (including direct purchases), the Secretary shall prohibit, for such financial institution, any new employment contract with a senior executive officer that provides a golden parachute in the event of an involuntary termination, bankruptcy filing, insolvency, or receivership. The Secretary shall issue guidance to carry out this paragraph not later than 2 months after the date of enactment of this Act, and such guidance shall be effective upon issuance.
  

• (d) SUNSET.—The provisions of subsection (c) shall apply only to arrangements entered into during the period1 during which the authorities under section 101(a) are in effect, as determined under section 120.
  

As the summary to the draft legislation explains:

• 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.
  

As for the Section by Section analysis, the draft legislation explains:

• Section 111. Executive Compensation and Corporate Governance.  Provides that Treasury will promulgate executive compensation rules governing financial institutions that sell it troubled assets. Where Treasury buys assets directly, the institution must observe standards limiting incentives, allowing clawback and prohibiting golden parachutes. When Treasury buys assets at auction, an institution that has sold more than $300 million in assets is subject to additional taxes, including a 20% excise tax on golden parachute payments triggered by events other than retirement, and tax deduction limits for compensation limits above $500,000.