While financial institutions will shy away from the hint of a “troubled condition” designation, such designations are unfortunately a common fact of life in today’s economy. Many more banks and thrifts are finding themselves subject to new compensation restrictions when they fall into the “troubled” category. After an institution is determined to be in troubled condition, it becomes subject to the restrictions on golden parachute payments set forth in 12 C.F.R. Part 359 (“Part 359”). If its condition continues to deteriorate, the institution might also become subject to the prompt corrective action (“PCA”) rules, which limits the ability to pay bonuses and increase salaries.
Overview of Part 359. Part 359 limits the ability of financial institutions and their holding companies to pay, or enter into contracts to pay, golden parachute payments to institution-affiliated parties (“IAPs”). The Part 359 troubled condition “taint” will flow from a troubled institution to its healthy holding company and also from a troubled holding company to a healthy institution (but not from a troubled institution, through a healthy holding company, to a healthy subsidiary).
An IAP is broadly defined and can include any director, officer, employee, shareholder, or consultant. In certain situations, it can also capture independent contractors including attorneys, appraisers, and accountants.
A “golden parachute payment” (“parachute payment”) is any payment of compensation (or agreement to make such a payment) to a current or former IAP of a troubled institution that meets three criteria. First, the payment or agreement must be contingent upon the termination of the IAP’s employment or association with the financial institution. Second, the payment or agreement is received on or after, or made in contemplation of, a determination that, among other things, the institution is in troubled condition. Third, the payment or agreement must be payable to an IAP who is terminated at a time when the institution meets certain conditions, including being subject to a determination that it is in troubled condition. Even where a contract pre-dates the troubled condition designation, any parachute payment payable thereunder will be prohibited by Part 359 while the institution is in troubled condition.
Certain types of payments and arrangements are excluded from the definition of a parachute payment. Generally, payments made under tax-qualified retirement plans, welfare benefit plan, “bona fide deferred compensation plans or arrangements,” and certain “nondiscriminatory” severance plans, as well as those required by statute or payable by reason of the death or disability of an IAP are excluded.
In addition to the general categories of excepted payments, the rules under Part 359 permit a financial institution to make certain parachute payments, or enter into agreements providing for parachute payments, where the institution obtains the prior approval of one or more regulatory agencies. Such approval is required to pay obligations that pre-date the troubled condition, for the institution to pay, or enter into an agreement to pay, severance to someone who is retained as a “white knight,” or to enter into agreements that provide for change in control termination payments (that are contingent on both the occurrence of a change in control and termination of employment). In nearly every case, if approval is granted, the approved severance payments will be limited to no more than 12 months of base salary (tax gross-ups will not be permitted in any form) to be paid over time and subject to claw back.
In October 2010, the FDIC issued Financial Institution Letter 66-2010 (“FIL-66-2010”) which expanded the information required to be submitted with an application for approval under Part 359 by requiring an institution to demonstrate that the IAP is not a “bad actor” and is not materially responsible for the institution’s troubled condition. The guidance also provides for a de minimis severance of up to $5,000 per individual that can be paid without regulatory approval, so long as the institution maintains records detailing the recipient’s name, date of payment and payment amount, and also maintains a certification covering each individual who receives a payment.
Overview of Prompt Corrective Action Rules. The PCA rules designate four capital categories: “adequately capitalized” (which is an institution in “troubled condition”); “undercapitalized;” “significantly undercapitalized;” and “critically undercapitalized.” If an institution is significantly undercapitalized or critically undercapitalized, the institution becomes subject to additional compensation restrictions. Undercapitalized institutions may also become subject to these additional restrictions. When subject to the PCA compensation restrictions, the institution generally cannot pay any bonus to or increase the salary level of senior executive officers.