Monday, March 1, 2010
No sooner did I return from the Spring Contracts conference in Las Vegas when I received an e-mail from a former students seeking guidance on a research project. The student sought help on seeking a contractual solution to recent failures in the derivative markets. He was interested in exploring whether there might be a way to hold accountable a company like AIG on the ground that it fraudulently induced parties to invest while through mismanagement it failed to assure that it had adequate collateral.
Ordinarily, I would have simply responded truthfully by saying that the question is beyond my expertise. Fortunately, for the student however, this time I did not have to leave it at that. Among the many presentations from which I benefited at the conference was one by Miriam Cherry & Jarrod Wong on clawbacks as a possible solution in such contexts. The paper that was the basis for their presentation can be found in Volume 94, 2009 of the Minnesota Law Review and can be downloaded from SSRN. Here is the abstract:
In the spring of 2009, public outcry erupted over the multi-million dollar bonuses paid to AIG executives even as the company was receiving TARP funds. Various measures were proposed in response, including a 90% retroactive tax on the bonuses, which the media described as a "clawback." Separately, the term "clawback" was also used to refer to remedies potentially available to investors defrauded in the multi-billion dollar Ponzi scheme run by Bernard Madoff. While the media and legal commentators have used the term "clawback" reflexively, the concept has yet to be fully analyzed. In this article, we propose a doctrine of clawbacks that accounts for these seemingly variant usages. In the process, we distinguish between retroactive and prospective clawback provisions, and explore the implications of such provisions for contract law in general. Ultimately, we advocate writing prospective clawback terms into contracts directly, or implying them through default rules where possible, including via potential amendments to the law of securities regulation. We believe that such prospective clawbacks will result in more accountability for executive compensation, reduce inequities among investors in certain frauds, and overall have a salutary effect upon corporate governance.
My student may not find exactly what he was looking for in the article, as Cherry & Wong are really proposing clawback clauses that could address the harms attendant to the next meltdown in the capital markets. Given the prospects for a new regulatory regime with teeth, it is wise for us to start bracing for impact now.