Law Students

Legal Drafting, Executive Compensation, and the Bailout Plan

By Casebook Sherpa

The bailout plan that Congress will vote on this morning is an interesting mix of handouts to failing banks and market incentives to insure failing - or potentially failing - mortgage-backed securities. The latter objective, among others, is what hung up the bill on Friday. (You can download the plan from the New York Times’ website here and read some good commentary here.)

I haven’t read it all, but I’ve perused enough to worry about the future of the free market. Basically, the Act provides the Secretary of the Treasury with far-reaching authority to purchase nearly any asset he deems to be failing, including those assets held by foreign investors. One thing I did notice is that there is potentially a meaningful drafting issue with the executive compensation section (Section 111). I wouldn’t have come back to that provision had I not seen several interviews with congressional leaders this morning.

Both MSNBC and Fox are playing clips from Speaker of the House Nancy Pelosi where she speaks of “the end of the era of golden parachutes.” And Senator Judd Gregg, one of the GOP’s top budget experts, spoke of the same thing during an interview this morning on one of the news networks. I’ve written plenty of soundbytes for politicians to know that you can only trust them so much. But the finality with which they spoke about the end of excess executive compensation really struck me in light of the drafting issue I noticed in Section 111.

So what does the plan actually say about executive compensation?

Section 111 of the bill says:

(b) DIRECT PURCHASES.?

(1) IN GENERAL. Where the Secretary determines that the purposes of this Act are best met through direct purchases of troubled assets from an individual financial institution where no bidding process or market prices are available, and the Secretary receives a meaningful equity or debt position in the financial institution as a result of the transaction, the Secretary shall require that the financial institution meet appropriate standards for executive compensation and corporate governance. The standards required under this subsection shall be effective for the duration of the period that the Secretary holds an equity or debt position in the financial institution.

Subsection (b) then provides three criteria for executive compensation:

(2) CRITERIA.?The standards required under this subsection shall include?

(A) limits on compensation that exclude incentives for executive officers of a financial institution to take unnecessary and excessive risks that threaten the value of the financial institution during the period that the Secretary holds an equity or debt position in the financial institution;

(B) a provision for the recovery by the financial institution of any bonus or incentive compensation paid to a senior executive officer based on statements of earnings, gains, or other criteria that are later proven to be materially inaccurate; and

(C) a prohibition on the financial institution making any golden parachute payment to its senior executive officer during the period that the Secretary holds an equity or debt position in the financial institution.

Here’s the drafting issue…

Subsection (b)(1) purports to take effect when “the Secretary receives a meaningful equity or debt position in the financial institution” (emphasis added). However, at every other mention of the Secretary’s equity or debt position omits “meaningful.”

Read literally, then, the provision’s requirements are triggered upon purchase of a meaningful stake but allows the requirements to stay in force as long as the Secretary holds any stake in the company. It does not seem so far-fetched that a Secretary bent on lowering executive compensation would use this as authority to make that happen at least at the group of companies in which he has a financial stake. It also does not seem so far-fetched that this is simply a first step to a broader effort at controlling executive compensation, as it’s frequently a tactic to attack big issues in piecemeal fashion. (Whether or not limiting executive compensation is a good thing is another debate, what we’re arguing is the potential effect of drafting in this Act.)

In practice, I suspect this will mean very little in the short-term. There is a sunset provision (albeit one that allows the Secretary to extend his authority under the Act - Section 120) that will likely lessen this Act’s long-term effects. There are several qualifications on which assets the provision applies to and it’s likely that any doubt would be clarified by the regulations promulgated by Treasury.

But the force of the rhetoric on this particular issue, given how complex the entire plan is, concerns me. Getting a foothold on an issue like this could be just what the doctor ordered for those chomping at the bit to cut into executive compensation.

Full post as published by Fight The Hypo on September 29, 2008 (boomark / email).