United States: The Emergency Economic Stabilization Act Of 2008 Extensively Regulates Executive Compensation, But Leaves Many Unanswered Questions

Last Updated: October 9 2008
Article by Steven J. Friedman and Ellen Sueda

The Emergency Economic Stabilization Act of 2008 (the "Act"), signed into law by President Bush on October 3, 2008, contains several provisions affecting executive compensation. Ambiguities in the Act, however, create questions as to the scope of the Act's provisions and permissible avenues of compliance.

The Act regulates executive compensation in two separate ways. Under one provision of the Act, institutions that benefit from government aid are directly prohibited from providing certain types of compensation to certain executives. Under another provision, the government uses the Internal Revenue Code of 1986, as amended, to prohibit deductions by these institutions and to tax their employees in the event certain compensation practices are not followed. This legislation is significant because the federal government has rarely strayed into the arena of directly regulating what types or levels of compensation may be paid, as opposed to regulating compensation by imposing tax sanctions or penalties. In this respect, the Act may represent an unprecedented level of activism by the federal government.

Because the penalties apply only to financial institutions that are assisted by the government under the Act, the lead decision makers of a troubled financial institution may be tempted to consent to an acquisition or investment by a private financial institution that is less favorable to shareholders than a transaction that includes federal assistance under the Act. This may be so despite decision makers' fiduciary obligations to maximize shareholder returns or, in the case of an insolvent corporation, to protect the interests of creditors.

In addition, because the applicable sanctions and penalties are limited to the arrangements entered into in connection with the current financial debacle, such sanctions and penalties will not prevent problems that may occur after the current financial crisis passes.

Compensation Restrictions in the Event of Direct Purchases by the Government

Section 111 of the Act sets forth compensation standards applicable where the government purchases troubled assets directly from a financial institution where no bidding process or market prices are available, if the purchase comprises a "meaningful equity or debt position." The Act does not define what constitutes a meaningful position so that, prior to the issuance of further guidance, financial institutions may not be aware of whether they are subject to these rules. The sanctions or penalties that are applied are limited to the top five executive officers (the "Top Five Executives"), who are disclosed on a public company's (and non-public company's counterpart) proxy statement or Form 10-K. (Note that the current version of section 280G of the Internal Revenue Code extends to a broader group of individuals, thereby potentially creating a mismatch in these rules.)

If these rules apply, there are three separate standards that must be met.

Compensation Must Exclude Incentives for Unnecessary and Excessive Risks

First, limits must be in place so that compensation "exclude[s] incentives for executive officers to take unnecessary and excessive risks that threaten the value of the financial institution during the period that the Secretary [of the Treasury] holds an equity or debt position in the financial institution." No definition is included that provides any clarity as to what would entail unnecessary and excessive risk. We believe that further guidance will be needed before this provision can be sensibly implemented by any financial institution. However, it is not inconceivable, based on the broad language contained in the Act, that many common incentive techniques are now outlawed. Financial institutions seeking to play it safe may, in fact, provide more compensation to executives as base pay without an incentive component. This may not be a policy direction that meets the goals of the Act but may, in fact, become an unfortunate byproduct. Also, it is quite conceivable that an unnecessary or excessive risk may not be clear until a financial institution has the benefit of hindsight.

Required Clawback of Certain Compensation Paid Based on Inaccurate Statements

In addition, financial institutions must now provide for recovery of any bonus or incentive paid to a Top Five Executive that was based on statements of earnings, gains or other criteria that are later proven to be inaccurate.

This provision is similar to the clawback provisions passed in 2002 under the Sarbanes-Oxley Act, under which CEOs and CFOs have been required to disgorge certain incentive payments in the event that misconduct results in the restatement of financial statements. However, under the Act, the clawback provision is broader, because it can affect more executives and can be triggered even if there no misconduct.

Prohibition of Golden Parachute Payments

There is also a provision in section 111(b)(2)(C) of the Act that prohibits financial institutions from making golden parachute payments to Top Five Executives during the period that the Secretary of the Treasury holds an equity or debt position in the institution. Interestingly, although another section of the Act, section 302, addresses parachute payments by broadening the types of payments subject to the provisions of section 280G of the Internal Revenue Code, section 111(b)(2)(C) of the Act (which provides an outright prohibition) does not define what is intended to be a golden parachute payment. Until further guidance is issued, it may not be unreasonable to assume that a "golden parachute payment" will be defined the same as an "excess parachute payment," currently defined in section 280G of the Internal Revenue Code.1 Accordingly, in this area as well, further guidance is necessary before a financial institution can institute meaningful policies.

Compensation Restrictions in the Event of Auction Purchases by the Government

If a financial institution sells more than $300 million of troubled assets to the federal government and at least some of those assets are sold through an auction purchase, there will be a prohibition on the financial institution providing a new employment contract to a senior executive officer that provides for "a golden parachute in the event of an involuntary termination, bankruptcy filing, insolvency or receivership." The Secretary of the Treasury is charged with issuing guidance in connection with this mandate not later than two months after the date of enactment of the Act. These provisions are effective until the government's authority to purchase troubled assets expires - this is currently December 31, 2009. This effective period may be extended until no later than two years following the enactment.

This provision, like the provision applicable to "direct purchases," also inexplicably does not define what is intended to fall within the meaning of a golden parachute payment for this purpose.

Tax Provisions Related to Executive Compensation

Section 302 of the Act provides for amendments to the Internal Revenue Code in the areas of the general deductibility of compensation and the provision of excess parachute payments. First, the Act broadens the rules under section 162(m) of the Internal Revenue Code to deny income tax deductions to certain financial institutions to the extent that the remuneration for any "covered executive" for a taxable year exceeds $500,000. Second, it expands the limits under the "golden parachute" rules of Internal Revenue Code section 280G to payments made to departing executives of failing financial institutions. These new provisions will apply to financial institutions from which the government is acquiring at least $300,000,000 of troubled assets.

Deduction Limit on Employee Remuneration

The Act disallows deductions of remuneration of over $500,000 paid to covered executives of a financial institution during the first taxable year of an employer in which the aggregate amount of troubled assets acquired by the government, when added to the assets previously acquired, exceeds $300,000,000, which specifically excludes assets sold through direct purchase from an individual financial institution. Deductions will also be limited to $500,000 during any subsequent taxable year that includes any portion of such period during which the Act is in effect.

A covered executive for whom the deduction limits will apply will include any employee who at any time during a taxable year is the CEO, the CFO, or one of the three highest compensated officers other than the CEO or CFO. If an individual is a covered executive for any taxable year, he or she will remain a covered executive in subsequent taxable years in which either services are performed or deductions are taken by an employer with respect to such compensation. It does not matter whether the executive would otherwise be considered a "covered executive" based on the then current compensation or title.

The definition of "covered executive" is distinguished from "covered employee," as defined in Internal Revenue Code section 162(m). Current guidance excludes the CFO from the definition of "covered employee," due to Internal Revenue Code section 162(m)'s reference to the Securities Exchange Act of 1934, as amended, and the change to the proxy reporting rules. Thus, unlike the definition of "covered employee," "covered executive" includes the CFO, as well as the CEO and three highest compensated officers.

What Compensation Is Counted?

Compensation will generally include all remuneration for a particular taxable year that a company would be able to deduct as an expense. Unlike current Internal Revenue Code section 162(m), the amount of compensation included to determine remuneration in excess of $500,000 includes performance-based compensation, including commission compensation, or compensation paid under a contract in effect on February 17, 1993.

Significantly, the Act denies deductions for compensation that is deferred into a later year if such compensation would have been nondeductible in the year in which it was earned. This is a departure from the manner in which section 162(m) of the Internal Revenue Code generally treats deferrals; that is, to permit deductions up to the limit applicable in the year in which the compensation is taxable to the executive, irrespective of whether it was deferred in a prior year. This provision also captures the carry-forward of expense deductions for companies with a net operating loss in the applicable taxable years.

Golden Parachute Provisions

The rules contained in the Internal Revenue Code that prohibit employer tax deductions for payments to certain departing executives after a change in control of an organization have been expanded to prohibit deductions on account of an involuntary severance of employment of a "covered executive" in connection with any bankruptcy, liquidation or receivership of the employer. These rules generally prohibit tax deductions for severance payouts of three times annual pay or greater. Again, the prohibitions on deductions is narrowed from the current individuals defined under section 280G of the Internal Revenue Code to only "covered executives."

The golden parachute provision excludes certain portions of current Internal Revenue Code section 280G, including arrangements (or amendments to arrangements) entered into one year prior to a "change in control," amounts that the company establishes as reasonable compensation, exemptions for small businesses, and the treatment of the company as a controlled group.

The provision is also limited to covered executives whose employment is terminated either involuntarily by the company or in connection with a bankruptcy, liquidation or receivership of the company. The Secretary of the Treasury is to establish guidance so that a company cannot avoid this provision by mischaracterizing the termination of the covered executive.

Impact of These Provisions

It does not appear that the Act will have a long-lasting effect on executive compensation. The Act is limited to financial institutions currently in distress, but does not contemplate that the same issues that financial institutions currently face may in fact occur in other types of businesses. If Congress was serious about re-engineering executive compensation, it could have extended the performance period that section 162(m) affects to a longer period to ensure that long-term, rather than short-term, gains of a company are considered in tying compensation to performance. In addition, a company in distress does not necessarily consider the tax deduction expense when the company is operating at a net operating loss. Accordingly, the loss of a deduction may not have the punitive effect the Act contemplates. Furthermore, executive contracts often contain tax gross-up provisions for the 20% excise taxes imposed on executives, which would result in no punitive effect on executives who may incur a penalty tax in connection with a parachute payment. The Act could have disregarded any contract provision that provided for a tax gross-up for such penalties and/or could have levied further penalties in connection with a gross-up.

Financial institutions that are covered by the government's assistance program will need to review current compensation practices. Even without a current clear mandate from the federal government as to what changes need to be made, each institution should inventory the areas that likely will need to be changed in light of the current legislative language. Further guidance will be needed, however, before the full impact of the Act can be assessed and all appropriate changes can be implemented.


1 Note that although section 280G of the Internal Revenue Code is entitled "Golden Parachute Payments," that section neither mentions, nor defines, "golden parachute payments."

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

In association with
Related Topics
Related Articles
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Mondaq Free Registration
Gain access to Mondaq global archive of over 375,000 articles covering 200 countries with a personalised News Alert and automatic login on this device.
Mondaq News Alert (some suggested topics and region)
Select Topics
Registration (please scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.


The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.


Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions