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<DIV><FONT size=2><STRONG><FONT size=5>Executive Pay Limits May Prove
Toothless<BR></FONT></STRONG><FONT size=3>Loophole in Bailout Provision Leaves
Enforcement in Doubt<BR></FONT>
<P><FONT size=-1>By Amit R. Paley<BR>Washington Post Staff Writer<BR>Monday,
December 15, 2008; A01<BR></FONT></P>
<P></P>
<P>Congress wanted to guarantee that the $700 billion financial bailout would
limit the eye-popping pay of <A
href="http://www.washingtonpost.com/ac2/related/topic/Wall+Street?tid=informline"
target="">Wall Street</A> executives, so lawmakers included a mechanism for
reviewing executive compensation and penalizing firms that break the rules.</P>
<P><STRONG><FONT color=#0000ff>But at the last minute, the Bush administration
insisted on a one-sentence change to the provision, congressional aides said.
The change stipulated that the penalty would apply only to firms that received
bailout funds by selling troubled assets to the government in an auction, which
was the way </FONT></STRONG><A
href="http://www.washingtonpost.com/ac2/related/topic/U.S.+Department+of+the+Treasury?tid=informline"
target=""><STRONG>the Treasury Department</STRONG></A><STRONG><FONT
color=#0000ff> had said it planned to use the money.</FONT></STRONG></P>
<P><STRONG><FONT color=#0000ff>Now, however, the small change looks more like a
giant loophole, according to lawmakers and legal experts. In a reversal, the
Bush administration has not used auctions for any of the $335 billion committed
so far from the rescue package, nor does it plan to use them in the future.
Lawmakers and legal experts say the change has effectively repealed the only
enforcement mechanism in the law dealing with lavish pay for top
executives</FONT></STRONG>.</P>
<P>"The flimsy executive-compensation restrictions in the original bill are now
all but gone," said <A
href="http://projects.washingtonpost.com/congress/members/g000386/"
target="">Sen. Charles E. Grassley</A> (Iowa), ranking Republican on of the <A
href="http://www.washingtonpost.com/ac2/related/topic/U.S.+Senate+Committee+on+Finance?tid=informline"
target="">Senate Finance Committee</A>.</P>
<P>The modification reflects how the rapidly shifting nature of the crisis and
the government's response to it have led to unexpected results that are just now
beginning to be understood. The <A
href="http://www.washingtonpost.com/ac2/related/topic/U.S.+Government+Accountability+Office?tid=informline"
target="">Government Accountability Office</A>, the investigative arm of
Congress, issued a critical report this month about the financial industry
rescue package that said it was unclear how the Treasury would determine whether
banks were following the executive-compensation rules.</P>
<P></P>
<P></P>
<P>Michele A. Davis, spokeswoman for the Treasury, said the agency is working to
develop a policy for how it will enforce the executive-compensation rules. She
would not say when the guidance would be issued or what penalties it might
impose. But she said the companies promised to follow the rules in contracts
with the department.</P>
<P>The final legislation contained unprecedented restrictions on executive
compensation for firms accepting money from the bailout fund. The rules limited
incentives that encourage top executives to take excessive risks, provided for
the recovery of bonuses based on earnings that never materialize and prohibited
"golden parachute" severance pay. But several analysts said that perhaps the
most effective provision was the ban on companies deducting more than $500,000 a
year from their taxable income for compensation paid to their top five
executives.</P>
<P>That tax provision, which amended the Internal Revenue Code, was the only
part of the law that contained an explicit enforcement mechanism. The provision
means the <A
href="http://www.washingtonpost.com/ac2/related/topic/Internal+Revenue+Service?tid=informline"
target="">IRS</A> must review the pay of those executives as part of its normal
review of tax filings. If a company does not comply, the IRS can impose a tax
penalty. The law did not create an enforcement mechanism for reviewing the other
restrictions on executive pay.</P>
<P>If a firm violates the executive-compensation limits, department officials
said, the Treasury could seek damages, go to court to force compliance, or even
rescind the contracts and recover the bailout money. "We therefore have all the
remedies available to us for a breach of contract," Davis wrote in an
e-mail.</P>
<P>Legal experts said those efforts could be complicated if the Treasury
outlines the penalties after companies have received bailout money. David M.
Lynn, former chief counsel of the <A
href="http://www.washingtonpost.com/ac2/related/topic/U.S.+Securities+and+Exchange+Commission?tid=informline"
target="">Securities and Exchange Commission</A>'s division of corporation
finance, said courts have sometimes placed limits on the government's ability to
impose penalties if there was no fair warning.</P>
<P>"Treasury might find its hands tied down the road," said Lynn, who is also
co-author of "The Executive Compensation Disclosure Treatise and Reporting
Guide."</P>
<P>Congressional leaders are also concerned that the Treasury might simply
choose not to enforce the rules or be unwilling to impose financial penalties
that could further weaken a firm and send the economy deeper into a
tailspin.</P>
<P>The Bush administration at first opposed any restrictions on executive pay,
congressional aides said. The original three-page bailout proposal presented to
lawmakers in September contained no mention of such limits. "Treasury was pretty
clear that they thought doing this exec-comp stuff would limit the effectiveness
of the program," said a Democratic congressional aide involved in the
negotiations, who, like others interviewed for this story, spoke on condition of
anonymity. "They felt companies might not take part if we put in these
rules."</P>
<P>Congressional leaders disagreed. By the morning of Saturday, Sept. 27, the
final day of marathon negotiations on the bill, draft language relating to taxes
and containing the enforcement provision applied to all companies participating
in the bailout programs, Democratic and Republican congressional aides said. But
then Treasury Secretary <A
href="http://www.washingtonpost.com/ac2/related/topic/Henry+M.+Paulson?tid=informline"
target="">Henry M. Paulson</A> Jr. and his deputies began pushing for the
compensation rules to differentiate between companies whose assets are purchased
at auction and those whose assets or equity are purchased directly by the
government, the aides said.</P>
<P>Congressional leaders from both parties thought Paulson wanted the
distinction for extraordinary cases like <A
href="http://www.washingtonpost.com/ac2/related/topic/American+International+Group+Inc.?tid=informline"
target="">American International Group</A>, which the government seized in
September. He wanted to be able to push executives out of companies that the
government controlled and have the flexibility to bring in strong new
executives, said one senior congressional aide.</P>
<P>"The argument that they were making at the time is that the direct investment
was going to be used only in circumstances where the company was AIGed, so to
speak," said a senior Democratic congressional aide.</P>
<P>Davis, the Treasury spokeswoman, confirmed that the Treasury pushed to place
fewer restrictions on executives at companies receiving capital infusions, but
she gave a different explanation. She said many of those firms are more stable
and are being encouraged to participate in the bailout to strengthen the overall
system. "The provisions for failing institutions should come with more onerous
conditions than those for healthy institutions whose participation benefits the
entire system," she said.</P>
<P>Lawmakers agreed to the Treasury's request that the measure apply only to
executives at companies whose assets were bought by the government through
auctions. In the executive-compensation tax section, a new sentence saying that
eventually was inserted.</P>
<P>Meanwhile, Paulson repeatedly told lawmakers that he did not plan to use
bailout funds to inject capital directly into financial institutions. Privately,
however, his staff was developing plans to do just that, Paulson acknowledged in
an interview.</P>
<P></P>
<P>Although lawmakers hailed the rules as unprecedented new limits on executive
pay, several were unhappy that the law was not stricter.</P>
<P>Under pressure from Congress, the Treasury issued regulations in October on
executive compensation and applied the tax-deduction limits to all companies
receiving bailout funds, although the legislation did not require it for firms
that received direct capital injections<I>.</I> But the Treasury failed to issue
guidelines requiring the IRS or any other agency to enforce the rules, and it
also failed to explain how the restrictions would be enforced.</P>
<P>The Treasury's regulations also instructed firms to disclose more
compensation information to the Securities and Exchange Commission. But
officials at the SEC do not think they have the authority to force companies to
disclose the kind of pay information required by the bailout law, according to
people familiar with the matter, though they hope companies will cooperate. John
Nester, an SEC spokesman, declined to comment.</P>
<P>Senators on the Finance Committee have expressed concern to Paulson and are
now considering whether they should amend the law to apply the enforcement
mechanism to all firms participating in the
bailout.</P></FONT></DIV></BODY></HTML>