Wednesday, July 1, 2009

How likely is recouping executive compensation, really?

Okay - so Americans used to carte-blanche corporate executives making a lot of money; bankers making a lot of money; and that errant as-seen-on-tv-product-guy making a lot of money. Before the current economic snap, no one really cared; or, at least, they didn’t care enough to litigate over it. Along comes Fall 2008, and since, each public disclosure of a corporate pay package inevitably throws the media cycle into full whirl, encouraging shareholders and creditors to litigate to recoup executive compensation paid, including bonuses. Because it’s really just that simple, right? No, it so is not.

Allen and I wrote a paper that acts as a solid foundation primer for counsel on both sides of this issue, Litigation and Recoupment of Executive Compensation (forthcoming). I wrote several sections, one which discussed New York State case law on the matter. There are a number of different legal avenues moving parties could take, and I will discuss a few here. As a threshold matter, understand plaintiffs have their work cut out for them.

Everyone in Manhattan knows about Richard Grasso. He was the former Chairman and CEO of the NYSE when it was organized as a not-for-profit entity. At the time of his departure in 2003, he had been party to a compensation agreement paying him $ 184 million over the course of five years (Grasso’s bonus in 2002 was $ 10.6 million). Then Attorney General Eliot Spitzer brought six claims against Grasso in an attempt to recoup the compensation. The claims ultimately failed; several as a result of loss standing on the Attorney General’s part (mid-litigation, the NYSE transformed into a for-profit corporation). The remaining claims failed because they did not satisfy the mental element of bad faith or knowledge, per New York’s Not-For-Profit Law. This bad faith or knowledge element mirrors the protection for-profit corporate actors enjoy at common law under the business judgment rule.

Corporate Waste
Basically, no matter how large or seemingly unreasonable the compensation awarded may be, if there is some relationship to the job performed – responsibilities and complexity of obligations, industry standards, expertise and experience – precedent suggests a New York court will not disturb a properly-determined compensation award absent bad faith or fraud. (n. 1). Precedent that does recoup executive compensation under a claim of corporate waste is quite old and involves smaller executive compensation packages than is the 2009 norm. As corporate counsel remarked to me recently, “When you’re talking hundreds of millions of dollars in cash flow each year, what is a $ 20 million compensation reward?”

Attorney General Andrew Cuomo’s Campaign for Governor of New York
Just a joke, Mr. Attorney General … At different points since the Fall of 2008, the Attorney General’s office has effectively leveraged The Martin Act and Fraudulent Conveyance claims to resolve very-public issues of executive compensation.

The Martin Act is one of New York’s blue sky provisions, giving the Attorney General broad powers to investigate and litigate matters of fraud where the sale of securities is involved. Attorney General Cuomo successfully relied on The Martin Act earlier this year to compel former Merrill Lynch CEO John Thain to divulge who received the Merrill bonuses prior to the Bank of America merger.

Fraudulent conveyance in New York is codified by statute, and allows creditors to recoup from transferees and beneficiaries any amounts transferred. Attorney General Cuomo has twice successfully leveraged the threat of fraudulent conveyance against American International Group. First in the fall of 2008, Cuomo secured AIG’s agreement to freeze salaries and bonuses. Then again in early 2009, Cuomo subpoenaed the names of the AIG employees receiving bonuses in light of further government subsidy. The move resulted in fifteen of the twenty highest bonus recipients voluntarily forfeiting their award. To what degree these results were achieved by the strength of the fraudulent conveyance claim, or by the heft of the Attorney General, is left for other legal observers to say.

The topic of executive compensation is interesting, and will certainly be discussed ad nauseam moving forward in the next several years. I will periodically revisit pieces of the research document Allen and I put together, but will also develop side inquiries in greater depth as this blawg moves through the summer.

And so good luck, you-activist-angry-plaintiffs-You … you’re going to need it.

n. 1: See e.g. Heller v. Boylan, 29N.Y.S.2d 653 (Sup. Ct. 1941).

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  1. Great post on an interesting topic Stephanie.

    On a somewhat related topic, there is lots of blame to go around when considering the recent financial meltdown. Finding the true culprits is not easy.

    However, as a policy matter, reigning in executive compensation probably is not the right place to start. For an interesting read regarding the “faux-populism” which surrounds the compensation issue (and energizes the media) see this essay by Spitzer -

  2. Anon at 923p,

    Hi - thanks for writing.

    We're on the same page >> although some execomp numbers are staggering, I don't know that the current populist rhetoric is as substantive as it is cathartic. And the public opinion is fickle >> others have intimated to me they feel that once the economy turns a corner, that this push to recoup execomp will blow over.

    I checked the Spitzer article you included; thanks. Playing off the last bullet point in the article ("empower[ing] shareholders"), the SEC is pushing ahead with the shareholder say-on-pay proposal for banks that took TARP money. See . I know Allen has done research on this, so I will leave any further comments for him.

  3. That's right, Stephanie. The Recovery Act requires the SEC to issue rules granting shareholders of TARP recipients a "say on pay." The Obama administration is also pushing for legislation authorizing the SEC to require "say on pay" for all public companies.


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