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By WILLIAM A. BOECK, senior vice president, insurance and claims counsel, for Lockton Financial Services

Section 101 of the Emergency Economic Stabilization Act creates the Troubled Asset Relief Program. The TARP allows the U.S. Treasury Secretary to buy troubled assets from eligible financial institutions under whatever terms and conditions he or she deems appropriate.

"Financial institution" is defined very broadly to include "any institution ... established and regulated under the laws of the United States or any State ... and having significant operations in the United States."

"Troubled assets" include mortgages, any securities or other instruments related to mortgages and under certain circumstances can also include any other financial instrument.

Although the EESA provides for the purchase of troubled assets, the U.S. Treasury has announced that it will focus instead on using the bailout funds to inject capital directly into financial institutions.

The Treasury plans to use $250 billion to purchase shares of banks and other institutions and has committed to using $40 billion to purchase preferred shares of American International Group Inc. as part of a revised bailout plan for the insurer.

The EESA also requires creation of an optional insurance program to guarantee the value of troubled assets. Premiums will be paid by financial institutions and will be based on the risk assumed. The interests of taxpayers are protected in three primary ways:

--When the government purchases troubled assets, Section 113 of the act requires the institution to provide the government with warrants, stock or senior debt instruments to assure receipt of value from the institution.

--The government is required to buy, manage and sell the troubled assets in order to maximize recoveries.

--Section 134 requires the president to submit legislation to Congress in October 2013 to recoup any remaining losses from the financial industry.

Although Section 302 of the law limits the tax deduction for compensation paid to senior executives to $500,000, the law does not limit overall compensation. Instead, for financial institutions participating in the TARP, the EESA precludes certain types of compensation and provides for recovery of amounts paid under certain circumstances.

Financial incentives to "take unnecessary and excessive risks that threaten the value" of the institution are prohibited.

The law also allows institutions to recover bonuses and other incentive compensation paid to senior executives in the event the institution's financial statements prove to be "materially inaccurate."

Finally, "golden parachute payments" will be prohibited for senior executive officers while the government holds an equity interest or debt. Similar golden parachute prohibitions will apply to executives of institutions that auction $300 million or more in troubled assets under the government's auspices.

Section 109 of the act requires the government to use its influence as the holder of mortgages and mortgage-backed assets to encourage loan services to modify loans to avoid foreclosure. The act allows the government to use loan guarantees and credit enhancements to facilitate loan workouts.

January 19, 2009

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