June 10 (Bloomberg) -- JPMorgan Chase & Co., Goldman Sachs Group Inc. and the eight other banks cleared yesterday to repay their U.S. government rescue money will be freed from legal limits on bonuses for their top 25 employees.

The pay curbs, stricter than those already included in Treasury department rules, were inserted by Senator Christopher Dodd, a Connecticut Democrat, as an amendment to the Obama administration’s economic stimulus plan in February. They expire when a bank repays money received from the Troubled Asset Relief Program even if the government still holds warrants to purchase the bank’s common stock, according to the legislation.

Financial executives and recruiters warned that banks under the restrictions would have a tougher time recruiting and keeping employees. Bank of America Corp., Citigroup Inc. and Wells Fargo & Co. are the largest banks left out of yesterday’s list of companies approved by the Treasury Department to refund the government.

“Stronger companies may really look to shore up their talent pool with top players and the place they’ll go hunting for them is companies with TARP restrictions,” said Steven E. Hall, managing director of New York-based Steven Hall & Partners.

For banks that had received more than $500 million of TARP money, the so-called Dodd amendment prohibits cash bonus payments to the five most senior officers and to the 20 “next most highly compensated employees.” Bonuses paid in restricted stock were allowed, as long as they didn’t vest until the TARP money was repaid and as long as the restricted stock isn’t worth more than one-third the employee’s total annual compensation.

How to Implement?

Banks have been waiting since February for guidance from the Treasury on how to implement the rule, including clarification on how to determine which 20 employees to include.

Bonus payments have traditionally made up the majority of pay for top executives on Wall Street, which capped salaries as part of an effort to tie compensation to revenue. Public scrutiny intensified last year when Merrill Lynch & Co. awarded $3.6 billion in bonuses after failing to make a profit in 18 months. Dodd’s amendment was added to the American Recovery and Reinvestment Act of 2009 after Merrill’s awards were publicized.

Some banks have already responded to the bonus limits by ratcheting up salaries.

Morgan Stanley, which plans to return the $10 billion in TARP money it accepted in October, said on May 22 it was doubling the base salary of Chief Financial Officer Colm Kelleher and raising salaries for Co-Presidents James Gorman and Walid Chammah, among other top executives.

Paying TARP

In addition to JPMorgan, Goldman Sachs and Morgan Stanley, the banks announcing yesterday that they plan to repay a combined $68 billion in TARP money were American Express Co., Bank of New York Mellon Corp., BB&T Corp., Capital One Financial Corp., Northern Trust Corp., State Street Corp. and U.S. Bancorp.

Until the firms buy back warrants the government received as part of its capital injections, they remain subject to some TARP restrictions, said V. Gerard “Jerry” Comizio, a senior partner in the banking and financial institutions group at law firm Paul, Hastings, Janofsky & Walker LLP in Washington.

The restrictions include limits on common stock dividends and repurchases as well as the Treasury’s own compensation provisions, which allow banks to recoup bonuses in some circumstances and prohibit banks from agreeing to give executives so-called golden parachute payments when they leave, he said.

To contact the reporters on this story: Christine Harper in New York at charper@bloomberg.net; Elizabeth Hester in New York at ehester@bloomber.net.

Last Updated: June 10, 2009 00:00 EDT