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Of Claws and Claims: The FDIC Proposes Rules Implementing the Dodd-Frank Act’s Liquidation Authority

March 25, 2011

Overview

The Dodd-Frank Act provides the FDIC with the authority to liquidate non-bank financial firms whose failure could adversely affect the financial stability of the U.S. In accordance with that authority, the FDIC has published for comment a refreshingly lucid rule establishing criteria for: determining whether a company may potentially become subject to the FDIC’s liquidation authority; recouping compensation from those deemed responsible for a company’s failure; avoiding fraudulent transfers; prioritizing expenses and unsecured claims; and establishing the administrative process for the determination of claims and the process for judicial review.

Photo by John Stracke. Some rights reserved.

Two aspects of the proposal are sure to draw scrutiny — the clawback of executive compensation and the claims priority process.

Clawback (Recoupment of compensation, Section 380.7)

Section 380.7 of the proposed rule discusses when the FDIC will seek to recoup compensation from those who are judged to be substantially responsible for a firm’s failure. In assessing whether an executive or director is substantially responsible for a firm’s failure, the FDIC will investigate how the senior executive or director performed his or her duties and responsibilities, and the results of that performance. Only those who are responsible for a loss that materially contributed to the firm’s failure will be held accountable. The FDIC is considering quantitative benchmarks to establish materiality including the percentage or magnitude of loss associated with the firm’s assets, net worth, and capital. The FDIC is soliciting  comments on these and other potential benchmarks. 

A rebuttable presumption of substantial responsibility will exist when the executive or director is the chairman of the board, CEO, president, CFO, or the like. The FDIC also will presume the substantial responsibility of an executive or director who has been adjudged by a court or tribunal to have breached his or her duty of loyalty to the firm. And the presumption will extend to an executive or director who has been removed from his or her position in accordance with the Dodd-Frank Act. The FDIC may also seek to clawback compensation based on other grants of authority in Title II of the Act.

Claims Priority Process (Priorities of expenses and unsecured claims, Sections 380.20-26.)

Subpart A of the proposed rule addresses the priorities of expenses and unsecured claims in a receivership. It is “based on the fundamental principle that any orderly liquidation should fairly treat similarly situated creditors and should ensure that the ultimate risk of loss for a failure of a systemically important financial company rests with the stockholders of the failed company.”

Subpart A integrates all of the Dodd-Frank Act’s provisions that determine the nature and priority of payments. First, the Subpart integrates the various statutory references to administrative expenses throughout the Act including identification of claims for amounts due to the U.S. Second, the Subpart confirms the statutory preference for claims arising out of the loss of setoff rights over other general unsecured creditors if the loss of the setoff is due to the receiver’s sale or transfer of an asset. Third, the Subpart clarifies the payment of obligations of bridge financial companies and the rights of receivership creditors to remaining value. Finally, the Subpart provides for the payment of post-insolvency interest on claims and for the determination of the index by which the limit applicable to certain claims for wages and benefits will be increased.

Comments should be submitted on or before May 23, 2011. View the proposed rule here.

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