Questions TARP Employees are Asking Today

On June 10, the Treasury Department issued an interim final rule (the “IFR”), effective June 15, providing guidance on the executive compensation standards applicable to companies participating in the Troubled Assets Relief Program (TARP). The IFR superceded all prior Treasury guidance with respect to the provisions of the Emergency Economic Stabilization Act of 2008, as amended by the American Recovery and Reinvestment Act of 2009. The analysis—which is not intended to be an exhaustive examination of the IFR—addresses a few of the more common questions we are being asked by employees of TARP companies as they are faced with significant restrictions on compensation.

(1) If I am “covered” (i.e., subject to pay restrictions) under TARP in 2009, will I continue to be covered in 2010?

Although the number of covered employees varies based upon the compensation provision (and, in the case of bonus payments, the amount of TARP assistance received by the employer), covered employees generally include the company’s senior executive officers (SEOs) as set forth in the company’s annual proxy, plus a specified number of the company’s most highly compensated employees based upon the prior year’s annual compensation. Therefore, the list of covered employees could change from year to year, creating both confusion and opportunity as compensation varies.

Accordingly, the Treasury has invited comments on how to keep companies from intentionally cycling employees in and out of covered status each year to allow them periods of freedom from TARP’s compensation restrictions. We note that, given that covered status is based on the prior year’s compensation and on proxy statement status, new hires appear not to be treated as covered employees in the year in which they are hired, and may be able to receive a sign-on bonus without it being subject to TARP restrictions, if such bonus is properly structured.

(2) I have been told there is no base salary cap, but the only incentive payment I can receive is in restricted stock or restricted stock units. If this is the case, what is the best vesting schedule my employer can offer under the IFR?

While the base salary cap has indeed been lifted, the limits imposed on incentive pay are significant. Certain covered employees (depending upon the amount of TARP assistance received by the employer) may receive bonus pay only in the form of long-term restricted stock or restricted stock units (RSUs), the value of which may not exceed one-third of the employee’s annual compensation.

Any such award must be forfeited if the employee does not remain with the company for at least two years from the date of the grant (unless his departure is due to disability or death, or a change-incontrol event occurs). Importantly, there are no exceptions for termination without cause or constructive termination.

In addition, the award may only become transferable or payable in 25% increments when the TARP recipient repays 25 percent of TARP funds (subject to sales permitted to pay taxes upon vesting). This provision would, however, permit full vesting after two years (subject to transfer/payment restrictions) even if the employee were to terminate employment before TARP is repaid.

(3) I have an employment agreement that provides for a guaranteed bonus. Can I receive it if my employer is under TARP?

Yes, but only if the agreement was in effect as of February 11, 2009 and created a legally binding right to the bonus. This grandfathering provision applies to retention awards and other incentive compensation provided under an employment agreement as well. A bonus that depends on the satisfaction of performance criteria would not create a legally binding right and thus would not be payable under the IFR.

(4) If I am dismissed from my job, could I receive severance pay provided under my company’s severance plan or my employment or separation agreement?

During the TARP period, severance pay to SEOs and the next five most highly compensated employees is prohibited, even if such pay is provided for by a binding employment agreement or company severance plan in effect as of February 11, 2009. Severance is considered to have been paid at the time of departure, so if a termination of employment occurs during the TARP period it is not permissible to simply delay payment until after the period has ended.

Note, however, that severance payments made in connection with a departure that preceded the employer’s TARP period are not prohibited even if the employer remains under TARP. Also, the IFR does not appear to prohibit entering into an agreement with a covered employee during the TARP period providing for severance to be paid in the event that the employee departs employment after the TARP period has ended or if he is otherwise no longer a covered employee under TARP.

(5) My company is in merger negotiations. Could I be eligible for severance or excise tax gross-up pay following the merger?

The nature of the merger would govern eligibility. If a TARP company is acquired by a non-TARP company, the employees of the merged entity will not generally be subject to TARP rules (there may need to be some clarification in the final rule on whether the form of acquisition could impact continuation of TARP requirements); note that excise and other tax gross-ups may need to be negotiated with the acquirer. If however, two TARP companies merge or a TARP company acquires a non-TARP company, TARP rules prohibiting severance and gross-ups would continue to apply.

The above list represents just a few of the questions TARP employees are asking. As employers begin to interpret and apply the IFR and the final regulations are issued, many more questions will likely arise.