Policy Gateway

TARP/Capital Purchase Program: Frequently Asked Questions

As the U.S. Treasury moves forward with its Capital Purchase Program (CPP) under the Troubled Assets Relief Program (TARP), we have been receiving questions from both institutional investors and issuers about how RiskMetrics Group will evaluate requests for authorizing or increasing preferred stock to participate in the CPP.

The following provides information on the TARP program and how RiskMetrics' analysts will approach these requests.

What is the TARP program?

The Troubled Asset Relief Program (“TARP”), a component of the Emergency Economic Stabilization Act of 2008, gives broad authority to the Secretary of the Treasury to purchase troubled assets from any financial institution. The Capital Purchase Program (“CPP”), a component of the TARP, is a voluntary program designed to encourage U.S. financial institutions to build capital to increase the flow of financing to U.S. businesses and consumers and to support the U.S. economy.

Under the CPP, Treasury will purchase up to $250 billion of senior preferred shares of qualified financial institutions (“QFIs”). The terms of the senior preferred shares are standard for all participants. In addition, Treasury will receive from each QFI warrants to acquire such firm’s common stock. QFIs must adhere to certain executive compensation standards for the period during which Treasury holds equity issued under this program. Where the Treasury buys assets directly, the institution must observe standards limiting incentives that could motivate risk-taking, requiring "clawback" of awards that are later determined not to have been earned (e.g., due to a financial restatement) and prohibiting golden parachutes. When the Treasury buys assets at auction, an institution that has sold more than $300 million in assets is subject to tax deduction limits for compensation above $500,000 to a senior executive. Firms must apply to the programs by Nov. 14, 2008. QFIs that are unable to issue preferred shares by the application deadline due to the need for a shareholder vote may receive preliminary approval, after which they will have 30 days in which to submit final documentation and fulfill any outstanding requirements.

What are the implications for shareholders?

Participation in the CPP has both economic and voting implications for holders of common stock. The senior preferred stock ranks senior to common stock and carries a liquidation preference of $1,000 per share. Senior preferred shares pay annual dividends at an initial rate of 5% until the fifth anniversary and 9% thereafter. The shares are not convertible and are generally non-voting other than class voting rights on matters that could adversely affect the shares. For as long as there are preferred shares outstanding, the company’s ability to declare or pay dividends on common shares will be subject to limitations. Further, the economic and voting rights of common shareholders will be diluted upon exercise of the warrants.

Does participation in the CPP require shareholder approval?

Participation in the CPP does not require shareholder approval. However, in order to participate in the program, firms must be able to issue preferred stock. Firms that do not currently have authorized preferred shares must obtain shareholder approval in order to issue preferred stock.

How does a company's request for preferred shares under the CPP differ from an ordinary request?

In most instances, requests for preferred shares do not cite a specific use of such shares. Rather, they cite potential uses such as future financing needs or acquisitions. In addition, most requests seek “blank check” preferred stock, which gives a company's board the power to issue shares of preferred stock at its discretion, with voting, conversion, distribution, and other rights to be determined by the board at the time of issue. As such, the impact on shareholders’ economic and voting rights cannot be known until the shares are issued, and shareholders may not be entitled to vote on such issuances. Moreover, blank check preferred stock can be placed with parties friendly to management and used to discourage bona-fide offers; therefore, such shares could be viewed as a takeover defense.

On the other hand, securities issued in connection with the CPP are more transparent, as the terms of preferred stock and warrants are standard for all participants. Issuers seeking approval for preferred shares will likely indicate if the shares are intended for use in the CPP.

How does RiskMetrics currently view requests for authorized preferred stock?

RiskMetrics Group’s benchmark policy regarding proposals to authorize or increase the number of preferred shares is as follows:

RiskMetrics Group generally recommends that shareholders vote AGAINST proposals to:

• authorize the creation of new classes of preferred stock with unspecified voting, conversion, dividend distribution, and other rights (“blank check” preferred stock)
• increase the number of blank check preferred shares authorized when no shares have been issued or reserved for a specific purpose

We will generally recommend that shareholders vote FOR proposals to:

• create “declawed” blank check preferred stock (i.e., stock that cannot be used as a takeover defense)
• authorize preferred stock in cases where an issuer specifies the voting, dividend, conversion and other rights of such stock and the terms appear to be reasonable.

RiskMetrics Group will recommend CASE-BY-CASE on proposals to increase the number of blank check preferred shares after analyzing the number of preferred shares available for issue given a company’s industry and performance in terms of shareholder returns.

Will requests for preferred shares to enable participation in the CPP be viewed differently?

RiskMetrics acknowledges the extraordinary market environment for financial firms and the desire of many financial institutions to strengthen their balance sheets. We believe that requests for preferred stock intended for use in connection with the CPP should be narrowly-crafted in order to provide shareholders with assurance that their rights will be protected. Therefore, RiskMetrics Group will apply a CASE-BY-CASE approach when evaluating CPP-related requests for preferred stock.

In general, we will consider the following factors when evaluating requests for preferred stock:

• Management’s rationale for the shares, as well as public disclosure regarding the company’s intention to participate in the CPP
• Shareholder protection measures such as “declawed” shares or a sunset provision applicable to newly-requested shares not used in connection with the CPP
• The company’s financial situation, including share performance and capital ratio
• The company’s existing governance structure, including the level of board independence, existing takeover defenses, and any problematic governance concerns

However, RiskMetrics Group will generally recommend a vote AGAINST requests for blank-check preferred stock that has not been declawed if the company would be permitted to issue shares for purposes other than CPP.

When will shareholders see these types of requests?

As of Nov. 4, 2008, approximately 40 applicants had been approved to participate in CPP. To date, several firms have filed definitive proxy materials seeking approval of preferred stock.