Bonus Restriction on Banks Receiving Government Bailout Money

It is well known that as part of the bank bailout bill, Congress imposed pay restrictions on executives at banks that receive government money. These pay restrictions were further strengthened in the American Recovery and Reinvestment Act of 2009 (the “Recovery Act,” a/k/a the “stimulus bill”). A noteworthy and particularly controversial pay limitation in the Recovery Act requires that bonuses to a certain number of employees (depending on how much government money the bank receives) be limited to long-term restricted stock, and the stock’s value may not exceed one third of the employee’s total annual pay (the “bonus restriction”). For example, an executive subject to the bonus restriction who is paid $1 million in salary would be limited to a bonus of $500,000 in the form of long-term restricted stock. The more government money a bank receives, the greater the number of employees that are subject to the bonus restriction. For example, a bank that receives $500 million or more from the government must apply the bonus restriction to its senior executive officers and at least the 20 next most highly-compensated employees.

The question of how to identify a bank’s “most highly-compensated employees” was left open in the Recovery Act. One interpretation was to designate “most highly-compensated employees” based on pay in the current fiscal year, while another interpretation was that “most highly-compensated employees” were identified based on pay in the previous fiscal year. The Treasury Department’s interim final rule, effective as of June 15, 2009, settles the question by stating that “most highly-compensated employee” status is determined based on annual pay earned in the prior year. This, however, does not resolve the “intentional cycling” issue.

Suppose a bank received $500 million of government money in late 2008 and will not repay the government for at least another couple of years. Pursuant to the Recovery Act, the bank in 2009 must impose the bonus restriction upon the twenty five employees who earned the most money in 2008 (“Group 1”). Due to the pay restriction, however, Group 1 is not likely to be the highest paid in 2009, so a different group of twenty five employees (“Group 2”) would be the highest paid in 2009. Group 2 would thus not be allowed to earn bonuses in 2010 while Group 1 could. This could result in a weird game of leapfrog where groups of twenty five employees trade places as the highest paid every year.

The Treasury Department addresses this issue in the interim final rule. It offers a couple of potential methods to mitigate “intentional cycling” by: identifying “most highly-compensated employees” based on an average of the preceding two or three years’ annual compensation, or requiring certain “most highly compensated employees” identified for one year to remain subject to the restriction for a certain number of additional years regardless of subsequent levels of compensation. The Treasury Department invites comment on this issue, including the extent “intentional cycling” is likely to occur, and potential ways to address the issue.

If you wish to comment on this issue or any topic addressed in the interim final rule, you can contact the Treasury Department by e-mail at executivecompensationcomments@do.treas.gov or via snail mail (in triplicate) to Executive Compensation Comments, Office of Financial Institutions Policy, Room 1418, Department of the Treasury, 1500 Pennsylvania Avenue, NW., Washington, DC 20220.

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