Document Type

Article

Publication Date

2012

Abstract

In July 2011, the Federal Deposit Insurance Corporation (FDIC) promulgated new rules implementing Title II of the Dodd-Frank Wall Street Reform and Consumer Protection Act. These rules define a cause of action to recoup compensation paid to senior executives and directors of failed nonbank financial institutions placed into the FDIC's "orderly liquidation authority" receivership. An action for recoupment is based on a negligence theory of liability, but it does not require establishing that an executive's conduct caused the financial institution any harm. The rules presume liability merely for having held executive responsibility prior to the firm entering receivership. The executive may rebut the presumption of negligent conduct, but not causation. Put simply, a senior executive or director can lose two years of pay even if he or she could conclusively establish the total absence of any link between his or her conduct and the firm's failure.

This Comment argues that disconnecting recoupment from causation leads to overdeterrence and perpetuates the dangerous phenomenon of "too big to fail." In particular, executives may abstain from taking optimal risks that may be mischaracterized later as negligent should other factors cause the firm's failure. Such overdeterrence is likely to cause talented executives to gravitate toward financial institutions that have the lowest risk of failure. Recoupment thus imposes a cost concomitant with a firm's perceived risk of failure, giving large, interconnected institutions an advantage when competing for managerial talent. Indeed, the liquidation of firms perceived as "too big to fail" may be so improbable that they can credibly offer executive compensation with little to no risk of recoupment.

The remedy for this deficient rule is to make causation a rebuttable presumption. Because executives can cheaply show that other factors were responsible for the firm's failure, they would discount potential recoupment liability chiefly by the likelihood of causing actual harm. This probability would not vary between firms, promoting healthy competition among financial institutions and reversing the arbitrary advantages conferred by the current regime on "too big to fail" firms. Retaining a presumption of causation would still ease the evidentiary burden of holding financial executives accountable for reckless behavior.

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