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August 2010 
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The Impact Of The TARP AIG Bonus Bill On The US Banking Sector |
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Claire Spencer, May 2009 |
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The issue of executive bonuses and compensation has perhaps enraged the US media and electorate more than any other precipitated by the financial crisis to date. So when it emerged in March that American International Group (AIG) was to pay out approximately $218m in bonuses to members of its financial services division after receiving a record-breaking $170bn in US taxpayer-backed bailouts last year, the reaction was predictable. It was also somewhat understandable, considering that the financial services unit was responsible for selling the credit-default swaps that brought AIG to its knees in the first place. Congress moved swiftly, and within days had produced Bill HR1586 to impose an additional tax on bonuses received from certain recipients of Troubled Asset Relief Program (TARP) bailout money. However, it has yet to be approved by the Senate, and there are fears that the Bill may even be unconstitutional.
Legislating a culture change
The premise of the AIG Bonus Bill is simple – if companies have received $5bn of TARP bailout money, then all bonuses they pay out will be subject to a 90 percent income tax surcharge.
The Bill is the latest of a number of attempts by the US government to use legislation to limit executive compensation practices in companies that have received government bailouts. “The Emergency Economic Stabilization Act of 2008 (EESA) originally limited the amount of tax deductible compensation payable to each senior executive of financial institutions participating in the TARP to $500,000 for as long as the US government holds an equity or debt position in the entity,” explains Richard Reilly, a partner at Baker & McKenzie. “The EESA also prohibited new employment contracts that provide for golden parachute payments upon involuntary termination, bankruptcy filing or receivership, and imposed tax deduction limits and tax penalties on certain golden parachute and severance payments,” he adds. However, these limitations were only imposed on the top five most highly compensated senior executive officers, and did not go as far as limiting the size of bonuses and other incentives.
The next step was taken by 2009’s American Recovery and Reinvestment Act (ARRA), which imposed broader limitations on executive pay for companies borrowing TARP money. The new rules can cover up to the 20 most highly compensated employees, depending on the amount borrowed. They prohibit bonuses, retention awards and incentive compensation – unless those elements were provided for in a contract dated 11 February 2009 or earlier. The rules also forbid severance payments of any kind to be made to senior executive officers and the top five most compensated employees. Furthermore, the ARRA prohibits incentive compensation practices that encourage executives to take risks that may jeopardise the health and value of the company, and instructs that bonuses based on materially inaccurate financial statements or other criteria must be paid back.
However, the ARRA came too late to prevent the AIG bonuses, which had been promised in contracts predating 11 February 2009. When this emerged, the US government, media and general public were livid, and it is regrettable that certain aspects of the AIG Bonus Bill reflect this fact. “In a very visceral way, HR 1586 responds to the anger, anxiety and desire for retribution that has come to characterise the popular debate about the financial crisis in the US. Whether adopted in its current form, or in some altered state, it will be difficult to understand how it will work in practice until the associated regulations are promulgated,” says James R Tanenbaum, a partner at Morrison & Foerster LLP. Whether this will even occur is yet to be seen, as the Senate has yet to act on the Bill, which was approved by the House of Representatives on 19 March. This may be because the majority of the offending AIG executives chose to return their bonuses, thereby removing the impetus for rushing the Bill into law. Of course, there is a possibility that the Bill was never intended to be enacted, with those behind it guessing (correctly) that the threat of enactment would be enough to produce the desired result.
Problems with the Bill
Unfortunately, lack of motivation is not the only issue surrounding the Bill, with many professionals suggesting that it may violate certain provisions of the Fifth Amendment. “There is a constitutional prohibition against adopting a Bill of Attainder,” warns Mr Tanenbaum. “A Bill of Attainder is an act of a legislature that has the effect of punishing a person or specific group of persons without benefit of a trial. Given the relatively narrow group of people who will, if enacted into law, be affected by HR 1586, it is likely that its application may be challenged in the courts on this constitutional ground.” However, he concedes that if the associated regulations are written in a way that anticipates this issue, the chances of a successful constitutional challenge are reduced. Of course, since the AIG executives have repaid the bonuses, the issue is unlikely to be challenged in court.
Furthermore, there is the fact that the AIG bonus payments were made under what seem to be valid agreements. “Most of the AIG bonus payments were retention incentive payments that were made to employees who agreed to remain at AIG for a stated period and payments were made only after the employees completed the agreed period of service. Thus, the bonuses had been fully earned. Also, not all of the bonuses were made to employees of AIG Financial Products Corp. Some of the retention payments were made to executives at AIG’s profitable property and casualty insurance subsidiaries that are not insolvent and are slated to be sold or spun off,” explains Mr Reilly. This may come back to haunt the US government. The retention payments were part of an overall effort to preserve the value of these profitable businesses, allowing for a controlled wind down of their investment portfolios. As such, it may be no coincidence that AIG’s profitable insurance subsidiaries have seen a number of high level defections in the last couple of months.
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