Justin Fox has been asking how we might make the miscreants pay (and here). I have two ideas to throw out.
My first thought is an old doctrine. If we could get the people who supposedly represent the people to formally acknowledge the insolvency of the institutions we are bailing out, there is a wide-ranging doctrine known as "fraudulent conveyance" that might help. Payments by a bankrupt firm during the period preceding the bankruptcy are subject to challenge and reversal, under the theory that preferential transfers by insolvent firms to some parties rather than others are inequitable. I don't know, from a legal perspective, how far back and how broadly the doctrine of fraudulent transfer could be applied to insolvent financials, but it's possible that a formal insolvency (e.g. a nationalization or receivership) could put a lot of people who got paid by banks during the boom at risk.
Yves Smith pointed this out a while back. I think it's worth taking a moment to wonder whether and how much the political resistance to formal nationalization is due to fears on the part of well-connected executives of being clawed-back via this doctrine. (Has fraudulent conveyance been aggressively pursued with respect to the Lehman bankruptcy? If not, why not?)
I hasten to add that I know very little about the legal details of fraudulent conveyance, whether it could in fact be applied to large, insolvent financials, what if any legislative action would be required to make the doctrine bite effectively, etc. I do know that even good-faith sellers of firms into leveraged buyouts are quite terrified of fraudulent conveyance, since even healthy firms become risky after the levering up and capital extraction that often followed these deals, and the former owners of previously viable firms can be made to take a serious hit. People who might know stuff about this (Buce?) are encouraged to weigh in. If we treated nationalizations as insolvency for the purpose of fraudulent conveyance, could we do some clawing back? Or is this a ridiculous idea?>>>MORE
This idea has been kicked around for a while now. As early as September 15, 2008, the very day of Lehman's bankruptcy, CFO.com, in the article "Creditors Could Go After Lehman Bonuses" said:
..."The key question is whether Lehman was solvent when it paid out the bonuses," wrote Adam Levitin, a law professor at Georgetown University, on his bankruptcy blog Credit Slips. "On an equity basis, almost assuredly yes, but on a balance sheet basis, that might be a closer call, depending on how things like MBS and CDOs are valued."
If the bank was not solvent when the bonuses were awarded, Levitin explained, the payout could be considered a "fraudulent transfer." One successful claim could challenge all of the bank's bonuses....MORE
In early October '08, Professor Jesse Fried, Boalt Hall School of Law, University of California, Berkeley posted "Uncle Sam should claw back Wall Street bonuses" on the Harvard Law School Corporate Governance Forum blog:
...The challenge would be finding legal authority to recover pre-meltdown bonuses. If a bailed-out firm were to file for bankruptcy, several provisions of the Bankruptcy Code could be used to recover pre-bankruptcy bonus payments to its executives. But if the rescue plan is successful, most of these bailed-out firms won’t be forced to file for bankruptcy. Is there a way to attack the bonuses paid by the firms that, thanks to government assistance, are able to steer clear of bankruptcy?
One possible source of authority is New York’s “fraudulent conveyance” statute, which applies to all firms in that state, including those that have not filed for bankruptcy. The statute gives creditors the right to recover a payment to an insider if, for example, the paying firm (1) did not receive fair consideration for the payment and (2) at the time had unreasonably small capital for its business operations. Some courts have held that managerial services do not constitute fair consideration for purposes of this type of statute. The statute may thus permit the government, to the extent it is considered an unpaid creditor of a bailed-out firm, to recover a bonus payment to one of that firm’s executives.
Will the federal government be able to recoup bonuses paid to Wall Street executives before the meltdown? We won’t know for sure until the government litigates these cases. But if the government loses money on the bailout, bringing these cases is the least the government can do for taxpayers - both those on the hook for the $700 billion rescue plan and those who may be asked to pay for a future bailout.
The comments are interesting:
It appears that former Lehman CEO Dick Fuld has thought this through (via the Times of London):
Ex-Lehman chief sold $13m home to wife for $100
Use the law.
Yes, on 9/23, I suggested for these reasons that we should build a phantom bankruptcy regime into the bailout bill. See http://uchicagolaw.typepad.com/faculty/2008/09/bailouts-and-ph.html
Comment by Randy Picker — October 4, 2008 @ 10:21 am
There is a provision in Sarbanes-Oxley for clawing back ill-gotten bonuses. Just get the SEC to do their job. I wrote about it here. http://www.retheauditors.com/2007/12/hey-sec-clawback-those-stolen-bonuses.html
Comment by Francine McKenna — October 4, 2008 @ 11:29 am