Orderly Liquidation Authority and Nonbank Financial Companies – Director and Officer Compensation Clawback
June 20, 2011
Authored by: Jerry Blanchard
The FDIC continues to work on its processes for liquidating a nonbank financial company whose failure is deemed to pose a significant risk to the financial stability of the United States. The bank holding companies of the largest 50 banks in the US are automatically included in that group. Final rules on what other companies will be included in that group are still being developed. There is currently a great deal of lobbying going on before the Federal Reserve by large mutual funds, hedge funds and insurance companies all of whom are trying to explain why they are not so important after all. A designation of systematically important carries with it significant consequences including the fact that such companies must develop a regulator approved “resolution plan” that outlines how the company could be liquidated in an orderly manner, federal regulators can preempt the use of bankruptcy by such entities and finally, the fact that a FDIC resolution effectively shuts out interested parties (management, shareholders and creditors) from a seat at the table during the resolution process.
One aspect of the proposed rules being developed by the FDIC concerns Section 210(s) of the Dodd-Frank Act dealing with recoupment of compensation from senior executives and directors of a failed nonbank financial company who were substantially responsible for the failed condition of the company. Section 201(s) provides that the FDIC may seek to recover “any compensation” paid to those parties in the previous two years. This would include salaries, bonuses, deferred compensation, golden parachute payments, stock option plans and profits realized from the sale of securities in the covered company. The proposed rule builds on this anti-incumbent theme by creating a presumption that a senior officer or director is substantially responsible for the company’s failure if they served as chairman of the board, CEO, president, CFO or any other position where they had responsibility for the strategic, policymaking, or company-wide operational decisions of the company. The presumption is rebuttable by providing evidence that the person did in fact perform their duties with the requisite skill and care.
It is unclear whether the FDIC position concerning the presumption of culpability will survive as the final rules are developed and whether it will stand up to legal scrutiny if it remains in the rules. For example, the Dodd-Frank Act itself does not appear to move the evidentiary burden to the directors and officers. It is also difficult to understand the interplay of the FDIC proposed rule with state laws that provide gross negligence standards for liability for officers and directors as well as defenses based on the business judgment rule. Moving the burden of proof to the directors and officers upends our normal understanding of how the government normally pursues parties against whom it is seeking to impose a monetary penalty. The issue for defendants in such actions will be whether the imposition of the sanction by the FDIC can be opposed as a practical matter.