Many senior executives of banks that were victims of the economic downturn, not reckless risk-taking, are waiting, often for months, for action by the Federal Deposit Insurance Corp. and other federal banking agencies on applications for modest severance payments.
The agencies are jammed with such requests under the golden parachute regulations and processing is excruciatingly slow. Of concern is an apparent hesitancy to approve golden parachute applications by banks that might still tumble into FDIC receivership, given that the Office of Inspector General is likely to skewer any bank regulator who allows more cash to be paid to departing executives to the detriment of the Deposit Insurance Fund.
The flood of enforcement actions continues to seep to more and more banks and bank holding companies even as the banking environment improves. Whether in the form of a formal cease-and-desist order, consent order or written agreement or an informal memorandum of understanding, the terms will likely include a statement that the institution is now subject to the restrictions on indemnification and severance payments.
Today, almost any compensation paid to bank executives on the way out the door of a bank in financial distress will be met with animosity in the press and among shareholders, bank customers and politicians. Seldom is it noted that for many banks, the fall from 1 and 2 to 3, 4 and 5 Camels ratings came suddenly and was driven by dramatic declines in asset quality. In hindsight, warning signs were often missed by bankers, regulators, advisers, financial analysts and commentators. Nevertheless, banks were downgraded and declared in troubled condition at breakneck speed as the economic downturn worsened and the avalanche of enforcement actions ensued.
Troubled-condition status and enforcement orders generally will not be lifted for at least one if not two or more examination cycles and even if sufficient new capital is raised to satisfy that key requirement of most enforcement orders. Therefore, if senior executives depart in the interim, they are not allowed to receive whatever severance may have been agreed in an employment agreement (such as 2 years salary), but an application must be made to the FDIC and also the Office of the Comptroller of the Currency or the Federal Reserve, depending on the bank's charter and whether a holding company is involved.
The FDIC issued guidance on golden parachute applications last October to clarify several requirements and standards for approval of such applications:
- The purpose of the golden parachute restrictions is to preclude troubled institutions from making payments to executives that are not in the best interests of the institution, to protect institution assets from wrongful disposition, to provide the FDIC with tools to combat fraud and abuse, and to prevent payouts that may be effectively at the expense of the Deposit Insurance Fund if the bank fails.
- The FDIC is unlikely to approve any golden parachute payments for institutions that remain in a precarious financial position, such as those that are "significantly" or "critically" undercapitalized.
- There are three exceptions or "permissible" golden parachute payments by troubled institutions: those necessary to bring in "white knight" management; certain change-in-control payments not to exceed 12 months' salary to keep current management sufficiently motivated while seeking potential acquirers; and situations that receive the "regulator's concurrence." These exceptions are in addition to certain others, including a new de minimis (under $5,000) exception for lower-level employees or nondiscriminatory severance pay plans, which usually provide less severance than is customary for departing executives.
- Enhanced certification and documentation are required for applications seeking the regulator's concurrence, including addressing whether the duties, responsibilities, oversight and performance of an executive fell within areas criticized in examination reports, such that the executive may be considered "substantially responsible" for the institution's troubled condition.
The dilemma for a bank submitting a golden parachute application to make severance payments to an executive is it requires the banking agencies to sign on to the conclusion required in the bank's certification that there is no reasonable basis to believe the executive committed fraud, violated banking laws or "is substantially responsible" for the institution's troubled condition. Unfortunately, the effect of this dilemma is a backlog of arguably well supported applications for modest severance payments to departing executives while banks seek sufficient additional capital to give the agencies comfort the institution won't fail after they approve the severance payment.
If the executive officers were not "substantially responsible" for an institution's troubled condition, who was? Maybe it was the economy in most cases. Just as it is unfair to broadly blame the bank regulatory agencies for taking action too late to prevent some banks from their risk-taking mistakes, it is unfair to delay or deny severance payments to many bank executives due to inaction or a reluctance to approve golden parachute applications while a bank remains formally in troubled condition. The guidance also emphasizes that approval of payment amounts generally permitted in other situations should not necessarily be expected in requests for the regulator's concurrence, depending on factors such as the impact of the payment on the institution and regardless of whether the employee's performance had a positive impact on the institution. Thus, severance payment applications may have to be for less than the 12 months' salary allowed under the change-in-control exception, and the informal rule that combination payments of salary, health insurance and allowing the retention of autos or laptops or the like will be acceptable if they aggregate less than 12 months' salary may not apply for departing C-level executives.
The lessons learned are that having an experienced and dedicated management team doesn't ensure success in poor economic times, but asset and other missteps identified in hindsight now bring swift enforcement actions and can shackle an institution with a troubled-condition status for a significant period. Giving deserved severance payments to executives who seek to depart during this time presents a substantial regulatory challenge.
