As the House and Senate weigh in on the Treasury’s ground-breaking $700 billion plan to bail-out the ailing financial sector, Democrats seem determined to include controls on executive pay at the firms that take advantage of taxpayer largess. As several firms (Citigroup and J.P. Morgan among them) are rumored to be looking at a buyout of Washington Mutual (WaMu). it’s worth taking another look at the employment contract that the troubled mortgage lender reached on September 7 with new chief executive Alan H. Fishman, who replaced long-time WaMu head Kerry Killinger.

In addition to taking the CEO post, 62-year-old Fishman will chair the board’s corporate development committee. He previously served as chairman of Meridian Capital Group, a commercial mortgage brokerage firm, and was president and chief operating officer of Sovereign Bank.

The terms of Fishman’s contract, which runs until 2011, suggest that WaMu’s directors were willing to pay generously for a CEO they believe can navigate the bank through continued turbulent waters, with a few safeguards for shareholders built in. According to an 8-K filing on Sept. 11, Fishman’s annual salary is set at $1 million, and his target annual bonus equals 365 percent of base salary, or $3.65 million, both matching the levels received by former CEO Killinger in 2007. Fishman’s long-term incentive awards will be determined by the board’s human resources committee, but--providing that he remains at the company through 2009--his grant value is guaranteed to be at least $8 million.

The Seattle-based financial institution has faced investor criticism in the past over its compensation practices. At the company’s annual meeting in April, investors withheld more than 30 percent support from five human resources committee members, in part because of WaMu’s decision to shield 2008 executive bonuses from its mortgage losses.

To bring Fishman aboard, WaMu also provided him “inducement” awards of cash and equity. This includes a $7.5 million signing bonus, 5 million options, and 612,500 restricted shares (worth approximately $2.6 million at the Sept. 5 closing price of $4.27 per share). WaMu also agreed to contribute up to $50,000 to cover Fishman’s legal expenses to negotiate the contract.

Notably, if Fishman resigns without good reason or his employment is terminated for cause within a “certain” (as yet undisclosed) time, he is obligated to repay all or part of the $7.5 million cash bonus. Also, vesting of the restricted shares occurs in equal increments over three years, subject both to his continued employment and the satisfaction of performance goals each year. These goals are to be “mutually agreed on” by Fishman and the human resources committee within 60 days after he begins employment.

The inducement options all have seven-year terms. Some also have performance conditions, although 25 percent (i.e., 1.25 million shares) are strictly time-based and will become exercisable one year after the grant date. The remainder are to vest in three increments, when the company’s average closing stock price over 20 consecutive trading days equals or exceeds the following levels: $10, $14, and $18 per share, respectively.

Fishman’s acceptance of these performance strings perhaps reflects his confidence that WaMu’s financial health can be restored. But in case things don’t work out, the board also strapped him into a “golden parachute” that will ease the pain of any departure. It provides that, if he is terminated without cause or resigns after a “constructive termination,” Fishman would receive lump-sum cash severance based on 2.5 times the sum of his salary and bonus (either the award paid for the preceding year or, if termination occurs in 2008 or 2009, the target amount of 365 percent of salary). In addition, any unvested time-based options would become immediately exercisable and remain so for 12 months. His performance-based options would continue to require satisfaction of the stock price targets, but they would remain outstanding until the later of one year after Fishman’s termination or three years after his hire date (subject to the seven-year option term). Any unvested shares in his inducement award of restricted stock would also vest as long as the applicable performance goals are satisfied within 12 months after his termination.

In case WaMu goes the way of Merrill Lynch and is acquired, Fishman’s severance package would be grossed up to compensate for any excise taxes related to change-in-control payments. A sale appears to be a real possibility. The New York Times reported that WaMu has retained Goldman Sachs to put the firm up for auction. On Sept. 17, TPG Capital, which provided WaMu with a $7 billion capital infusion earlier this year, said it was willing to accept dilution of its stake to facilitate a sale or outside cash infusion.

For his part, Fishman agreed to covenants related to confidentiality and intellectual property rights, as well as a two-year post-employment non-solicitation and non-competition agreement. He may waive the latter in the event of his termination without cause or “constructive” termination, but only if he also waives his right to severance benefits.

Some Severance Payments Beat the Regulators
The Federal Housing Finance Agency, which took control of Fannie Mae and Freddie Mac, says it will curtail severance payments to their ex-CEOs. But at least two CEOs of ailing firms may have gotten away with hefty golden parachutes before the government could intervene.

Based on information in the company’s 2008 proxy statement, WaMu’s board deemed Kerry Killinger’s separation a “termination without cause,” which should entitle him to a cash severance payment of $16.5 million (as disclosed in the proxy). That is based on three times the sum of his base salary and the higher of his actual or target bonus. Killinger’s equity awards are also slated to be cashed out--that portion of his parachute was worth more than $5.8 million at the end of 2007, but only about $1.8 million based on the Sept. 5 closing price prior to his Sept. 7 termination date. Killinger, a 32-year veteran of the company, also had accrued pension and deferred compensation totaling about $18 million, according to proxy disclosures.

Of course, the feds have not taken over WaMu, but at AIG--which they have--former CEO Martin Sullivan was ousted in June as a resignation for “good reason.” He was thus entitled to approximately $19 million in cash termination pay, consisting of a $15 million severance payment and a pro rata bonus of $4 million, according to an AIG 8-K filing on July 1. Under an employment agreement that Sullivan had negotiated with the company in March 2005, he was entitled to receive only cash severance payments after a resignation for “good reason.” However, as part of the March 2008 extension of his contract, Sullivan became eligible for continued vesting of long-term awards that the company said were worth about $28 million at that time; some are subject to performance goals that presumably will not be met, however.