The Advisors' Blog

– Steve Quinlivan, Leonard, Street and Deinard

Here’s something that I recently blogged on the “Dodd-Frank Blog”: The FDIC has adopted final rules which provide that the FDIC, as receiver of a covered financial company, may recover from senior executives and directors who were substantially responsible for the failed condition of the company any compensation they received during the two-year period preceding the date on which the FDIC was appointed as receiver, or for an unlimited period in the case of fraud.

A “covered financial company” is a financial company, other than an insured depository institution, which the Treasury Secretary has determined satisfies the criteria for FDIC receivership under Section 203(b) of the Dodd-Frank Act. Among other things, a determination by the Secretary under Section 203(b) requires a determination that the failure of the financial company would have serous adverse effects on the stability of the United States. “Financial companies” means bank holding companies, nonbank financial companies supervised by the Federal Reserve System and companies the Federal Reserve has determined are predominately engaged in activities that are financial in nature.

“Compensation” is broadly defined to mean any direct or indirect financial remuneration received from the covered financial company, including, but not limited to, salary; bonuses; incentives; benefits; severance pay; deferred compensation; golden parachute benefits; benefits derived from an employment contract, or other compensation or benefit arrangement; perquisites; stock option plans; post-employment benefits; profits realized from a sale of securities in the covered financial company; or any cash or noncash payments or benefits granted to or for the benefit of the senior executive or director.

The proposed rule provided a standard of conduct in which, among other things, a senior executive or director would be deemed “substantially responsible” if he or she failed to conduct his or her responsibilities with the requisite degree of skill and care required by that position. The final rule clarifies the standard and provides that a senior executive or director would be deemed “substantially responsible” if he or she failed to conduct his or her responsibilities with the degree of skill and care an ordinarily prudent person in a like position would exercise under similar circumstances. The revision clarifies that the standard of care that will trigger a clawback is a negligence standard; a higher standard, such as gross negligence, is not required.

In the event that a covered financial company is liquidated under Title II of the Dodd-Frank Act, the FDIC as receiver will undertake an analysis of whether the individual has breached his or her duty of care, including an assessment of whether the individual exercised his or her business judgment. The burden of proof, however, is on the senior executive or director to establish that he or she exercised his or her business judgment. State “business judgment rules” and “insulating statutes” will not shift the burden of proof to the FDIC or increase the standard of care under which the FDIC as receiver may recoup compensation.

The proposed rule provided that, in certain limited circumstances, a senior executive or director would be presumed to be substantially responsible for the failed condition of the covered financial company. The use of rebuttable presumptions for those individuals under the limited circumstances in the final rule is aligned with the intent shown in the statutory language; thus, the presumptions remain unchanged in the final rule.

The following presumptions apply for purposes of assessing whether a senior executive or director is substantially responsible for the failed condition of a covered financial company:

-The senior executive or director served as the chairman of the board of directors, chief executive officer, president, chief financial officer, or in any other similar role regardless of his or her title if in this role he or she had responsibility for the strategic, policymaking, or company-wide operational decisions of the covered financial company prior to the date that it was placed into receivership under the orderly liquidation authority of the Dodd-Frank Act;
– The senior executive or director is adjudged liable by a court or tribunal of competent jurisdiction for having breached his or her duty of loyalty to the covered financial company;
– The senior executive was removed from the management of the covered financial company under 12. U.S.C. 5386(4); or
– The director was removed from the board of directors of the covered financial company under 12 U.S.C. 5386(5).

The FDIC anticipates that it will seek recoupment of compensation through the court system using a procedure similar to the procedure that it currently uses when it seeks recovery from individuals whose negligent actions have caused losses to failed financial institutions. In those situations, the FDIC as receiver undertakes an investigation to determine if there are meritorious and cost effective claims and, if so, staff requests authority to sue from the Board or the appropriate delegated authority. Similarly the FDIC anticipates that it will investigate whether the statutory criteria for compensation recoupment are met, and, if so, staff will request authorization of a suit for recoupment. The final rule reflects this procedure by indicating that the FDIC as receiver may file an action to seek recoupment of compensation.