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Flaws in the AIG Trust

By Harvard Law School Program on Corporate Governance

I had the opportunity to testify before the House Oversight Committee recently on a panel along with Ed Liddy, the CEO of AIG, and the three trustees nominated by the Federal Reserve to manage the government’s $180 billion investment in AIG. The subject of my testimony, available here, was the Trust Agreement designed by the Federal Reserve Bank of New York to form the AIG trust. This Trust Agreement was crafted during Secretary Geithner’s tenure at the NY Fed, and Secretary Geithner has announced that he will be creating a Trust in the near future to manage the government’s voting common equity in Citigroup and other TARP banks. One concern motivating my testimony is that the flaws in the AIG Trust will find new life in these subsequent TARP Trusts. This is of particular concern because the government and the trusts it creates enjoy unprecedented immunity, despite being a controlling shareholder, under Section 3(c) of the Exchange Act, the Emergency Economic Stability Act, and through sovereign immunity principles generally.

The first cause for concern in the AIG trust is that the fiduciary duty of the trustees is not clearly defined, and is likely to be defined by the Treasury Department. The document states that the trustees’ standard of care is to act “in or not opposed to the best interests of the Treasury.” Though “Treasury Department” is a defined term in the document, “Treasury” is not. The AIG trustees argued that their personal understanding was they were required to maximize the value of the taxpayer’s investment, but that is not required by the AIG Trust. This threatens the very purpose of the AIG Trust, which is to serve as a buffer from the short term political interests of the government that may threaten AIG’s long term financial health. For more on that threat, see my op-ed in Forbes here.

Another controversial issue with the AIG Trust is that it includes a corporate opportunity opt-out provision. This permits the Trustees to personally take business or investment opportunities that fall within AIG’s line of business, and that they learn about through their service as Trustees, without notifying or getting permission from AIG or the Federal Reserve. Corporate Opportunity opt-outs are not unheard of in the corporate world, though they are controversial, and their use in this context requires serious consideration. Part of the testimony also featured a spirited debate between myself and one of the Trustees, also the CEO of El Paso Energy, over whether the indemnification provisions included in the Trust are consistent with the level of indemnification permitted for directors of Delaware corporations. I noted that Delaware does not permit indemnification for actions not in good faith, a limitation which is not included in the AIG Trust. The broadcast is available on C-Span here.

Designing the Trusts that manage the government’s investment in TARP Banks, Financial Companies, and the Automotive Industry requires precision and caution. Poor draftsmanship in these deal documents could have serious consequences for the government’s investment in TARP, as well as for the holdings of private shareholders in TARP companies.

Full post as published by The Harvard Law School Corporate Governance Blog on June 13, 2009 (boomark / email).