Emergency Economic Stabilization Act of 2008 – Troubled Asset Relief Program
The Emergency Economic Stabilization Act of 2008 (the “Act’) was signed in to law on October 3, 2008. This legislation is the most significant economic intervention by the United States Government in the nation’s financial services industry since the Great Depression. The primary component of the legislation is the Troubled Asset Relief Program (“TARP”) which authorizes the Secretary (the “Secretary”) of the U.S. Department of the Treasury (“Treasury”) to purchase residential and commercial mortgage loans, mortgage-backed securities or other obligations. Other important provisions of the TARP include: loss mitigation techniques such as authorization for Treasury to obtain equity or debt from participating banks and to pursue independent recoupment from financial institutions under certain conditions; procedures for contracting and oversight, mechanisms to avoid foreclosure; limits on compensation to executives of companies receiving assistance; procedures for reviewing and modifying mark to market accounting; temporary increases in FDIC coverage; and miscellaneous considerations. The Secretary is required to establish program guidelines no later than two business days after providing the first assistance or 45 days after enactment of the Act, whichever first occurs. The Secretary’s authority to purchase and insure troubled assets terminates on December 31, 2009, unless extended through October 3, 2010, upon certification by the Secretary to Congress that such an extension is necessary and disclosure of anticipated costs to the taxpayers of such an extension.
Under the TARP’s initial phase, the maximum amount of government assistance for troubled asset purchases is limited to $250 billion outstanding at any one time. Upon notification of Congress by the President, the limit may be increased to $350 billion. The Secretary is authorized to purchase a maximum of $700 billion in troubled assets outstanding at any one time after the President sends Congress a written report regarding the Secretary’s plan to exercise such authority. All revenues and sales proceeds from troubled assets are paid into the general fund of the Treasury. The TARP will be implemented under the Office of Domestic Finance within the Treasury through a newly created Office of Financial Stability which is governed by a Financial Stability Oversight Board. The composition of the Board includes Chairman of the Federal Reserve, the Secretary of the Treasury, the Director of the Federal Housing Finance Agency, the Chairman of the SEC, and the Secretary of HUD.
The principal provisions of the TARP include the following:
Purchase and Guaranty of Troubled Assets
Pursuant to the TARP, the Secretary is authorized to purchase residential or commercial mortgages and securities, obligations, or other instruments, based on or related to such mortgages, that were issued on or before March 14, 2008 and any other financial instrument the Secretary determines necessary to promote financial market stability. The second component of troubled assets is apparently broad enough to include non-mortgage assets, such as auto loans, student loans and instruments linked to those loans, and so forth. Before exercising authority with regard to this second category, the Secretary must consult with the Chairman of the Oversight Board and provide prior written notice of his determination to the appropriate congressional committees.
Interestingly, the TARP does not require that a financial institution own a troubled asset as of a particular date in order for it to be eligible for sale under the TARP; however, unjust enrichment provisions of the TARP make it clear that financial institutions may not purchase assets from third parties with the expectation that they can flip them at a higher price under the TARP. The Secretary is required to make purchases at the lowest price that is consistent with the purposes of the TARP, including using auctions or reverse auctions where appropriate. Private partner direct purchases from a financial institution may be made, provided that the Secretary ensures that the purchase price is reasonable and reflects underlying value of assets consistent with the long-term viability of the financial institution and whether such a private purchase represents the most efficient use of funds under the TARP.
To promote transparency and integrity, the Secretary is required by the TARP to make available to the public a description, amounts, and pricing of all assets purchased within two business days after the purchase, disposition, or trade.
The Secretary is also required to establish a program to guarantee troubled assets originated on or before the same trigger date of March 14, 2008. Financial institutions participating in the guarantee program must pay premiums for the guarantee in an amount determined by the Secretary, which amount may vary based on the credit risk of the troubled asset. Premium and pricing must be at a level to create reserves sufficient to meet anticipated claims and to ensure that taxpayers are fully protected. Troubled assets will be guaranteed up to 100% of the amount of the principal and interest on such assets, and premiums will be held in a Troubled Asset Insurance Financing Fund. Finally, the Secretary’s purchase authority limits under TARP will be reduced by an amount equal to the difference between the total outstanding guaranteed obligations and the balance of the Troubled Asset Insurance Financing Fund.
Equity and Debt Investments by Treasury
An important component of the Act and the TARP is the inclusion of mechanisms to mitigate costs to Treasury and hence to the taxpayer. Accordingly, Treasury is not permitted to purchase troubled assets from an institution unless Treasury receives an economic stake in that institution. Publicly-traded institutions are required to issue to Treasury a warrant for the right to receive non-voting common or preferred securities or voting stock provided Treasury agrees not to exercise voting power. Institutions that are not publicly traded must provide a warrant for non-voting common or preferred stock or voting stock for which Treasury agrees not to exercise voting power or a senior debt instrument providing for a reasonable interest rate premium. A note here that an emphasis is placed on the liquidity of the investment taken by Treasury to ensure prompt and efficient exit strategies for these investments. This also provides a mechanism for Treasury to make direct equity investments into troubled institutions.
The TARP also requires that terms and conditions of the warrant or debt instruments must be designed to provide for reasonable participation by Treasury in equity appreciation of warrants or protections against debt instrument losses. Warrants must also contain anti-dilution provisions typically employed in capital markets transactions. Importantly, Treasury may establish a de minimus exception to the requirement of reimbursement through warrants and debt instruments in situations where an individual financial institution sells less than $100 million in troubled assets under the TARP. Finally, the TARP provides that five years after enactment, the Director of OMB with the advice of the Director of the Congressional Budget Office is required to submit a report to Congress on the value of the assets of the program. If there is a shortfall between the amount spent by Treasury and the value of the assets received by TARP, the President is required to submit a legislative proposal that recoups from the financial industry an amount equal to the shortfall. This recoupment power is intended to ensure that TARP does not add to the national debt.
Contracting Procedures and Oversight
The Act provides significant flexibility in selecting managers for the assets acquired under the TARP. The Act provides a waiver from various federal acquisition regulations but does require a justification for contract actions be communicated to certain House and Senate committees within seven days of those acts occurring. The bill directs the Secretary to design a streamlined process to solicit proposals from a broad range of vendors, including incentives for minority and women-owned businesses and the publication of program guidelines to be used by the TARP for selecting asset managers.
Oversight is provided by the Financial Stability Oversight Board (again composed of Chairman of the Federal Reserve, the Chairman of the OCC, the Secretary of the Treasury, the Secretary of HUD, and the Director of the Federal Housing Finance Agency). The Act empowers the Oversight Board to appoint a Credit Review Committee to evaluate the exercise of all authority under the TARP. In addition, a Congressional Oversight Panel is established to review the Secretary’s use of authority under the TARP, the current state of financial markets and the regulatory system.
Finally, a Special Inspector General for the TARP will be appointed by the President to conduct audits and investigations of the purchase, management, and sale of assets by the Secretary under the Act and to collect and report quarterly to certain congressional committees. Furthermore, the Comptroller General is required to oversee the program to ensure that strong internal controls are in place and to conduct a study to determine the extent to which leverage was a factor behind the current financial crisis and the role of the OCC, the Federal Reserve, and the banking agencies.
Avoiding Foreclosures
The TARP provides additional authority to the Secretary to avoid foreclosures on individual loans and loan portfolios and securities. The TARP requires that to the extent residential mortgages, residential mortgage-backed securities, and other assets secured by residential real estate, including multi-family housing, are held, owned, or controlled by the Secretary or by a federal property manager, each will seek to maximize assistance to homeowners and encourage servicers to take advantage of programs to minimize foreclosures. Programs authorized include loan modifications that include reduction of interest rates, reduction of loan principal, and other similar loan modifications. For residential rental properties, modifications may include the continuation of existing government rental subsidies.
Executive Compensation Limits
Before selling troubled assets under the TARP, a financial institution must agree to certain restrictions on executive compensation pursuant to rules that the Treasury Secretary is required to implement through the issuance of rules or other guidance. The guidance is required no later than two months after the date of enactment, or December 3, 2008.
Types of executive compensation restrictions vary depending on whether the troubled assets are purchased directly or through an auction process. For direct purchases in situations where Treasury receives a meaningful equity or debt position, the financial institution must have implemented limits on compensation that excludes incentives for executive officers to take unnecessary or excessive risks, a provision for the recovery by the financial institution of any bonus or incentive compensation paid to a senior executive officer (generally the top five executives) based on statements of earnings, gains, or other criteria that are later proven to be materially inaccurate, and a prohibition on the financial institution making any golden parachute payments to senior executives or officers.
If Treasury acquires the assets through an auction process, the financial institution may not enter into any new employment contracts with senior executive officers that provide a golden parachute in the event of involuntary termination, bankruptcy filing, insolvency, or receivership. If Treasury purchases troubled assets at auction from a financial institution, there are limits on the ability of the institution to deduct as a business expense any compensation over $500,000 to certain executives. These auction related restrictions only apply with a financial institution that sells troubled assets under the TARP in an aggregate amount exceeding $300 million.
Mark to Market Accounting / FAS 157
The Act authorizes the SEC to suspend application of FAS 157 for any class or category of transactions the SEC deems appropriate and is consistent with protection of investors. The Act also requires the SEC, in consultation with the Federal Reserve and the Secretary, to conduct a study of mark to market accounting standards as provided in FAS 157 including its effects on a financial institution’s balance sheet, its impact on bank failures in 2008, its impact on the quality of financial information available, the process used in developing accounting standards, and the advisability of modifying these standards. Importantly, the SEC Office of Chief Accountant and the Staff of the Financial Accounting Standard Board clarified their views on fair value accounting in a release issued on September 30, 2008, three days before enactment of the Act.
Increase in FDIC Coverage
The Act provides for the increase in FDIC coverage from $100,000 to $250,000 per depositor until December 31, 2009.
Miscellaneous
Miscellaneous features of the Act include the following:
(1) Losses (or gains) from sale or exchange from Fannie Mae and Freddie Mac preferred stock between January 1, and September 7, 2008 shall be treated as ordinary loss (or income), providing a tax break for institutions that unloaded the stock at a substantial loss during this period preceding the insolvency of both Fannie Mae and Freddie Mac.
(2) Coordination with foreign authorities and central banks – The Secretary is required to coordinate, as appropriate, with foreign financial authorities of central banks to work toward the establishment of similar programs by such authorities and central banks.
(3) FDIC authority regarding enforceability of certain agreements – Section 13(c) is amended to include a provision that renders unenforceable as contrary to public policy any existing or future standstill, confidentiality, or other agreement that directly or indirectly affects, restricts, limits, or prohibits any person from offering to acquire or acquiring (or using previously disclosed information in connection with acquiring) all or any part of any insured depository institution in connection with any transaction in which the FDIC exercises its authority under Sections 11 or 13 of the Federal Deposit Insurance Act. (4) Upon consideration of the role of Credit Default Swaps in the credit crisis, the Secretary must provide a report to Congress by April 30, 2009 analyzing the current financial regulatory system for financial markets, including the over-the-counter swaps market and government-sponsored enterprises.
(5) Judicial review of the Secretary’s actions under the Act and pursuant to his TARP authority result in those actions being set aside only if they are alleged to be arbitrary, capricious or an abuse of discretion, or otherwise not in accordance with the law.
(6) No lawsuits or claims may be filed against the Secretary by any financial institution or entity that transfers assets under the TARP or any other program under the Act.
Recognizing that timely response to the imminent challenges in our financial industries calls for integrated skills, Troutman Sanders has formed its Credit Crisis & Government Intervention Task Force, comprised of lawyers from our bankruptcy, insurance, securities and corporate governance, financial institutions, lending and finance, real estate, litigation, and white collar investigations practice groups. Members of the Task Force include former federal prosecutors, bank regulators, specialists in directors and officers issues, and corporate reorganization. With our merger with Ross Dixon and Bell on January 1, we will join a very deep skill set in the issues pervading the earlier S&L crisis.
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