On March 15, 2011, the Federal Deposit Insurance Corporation (FDIC) issued a Notice of Proposed Rulemaking (NPR) implementing certain orderly liquidation authority (OLA) provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Act). Written comments on the NPR must be received by the FDIC not later than 60 days after publication in the Federal Register. It is imperative that those potentially impacted by this NPR provide timely comments on the NPR before a final rule is issued. Once the comment period ends and a final rule is published, successfully litigating over the meaning and coverage of the final rule resulting in judicial “rule making” are unlikely to be successful since the court will likely adopt a principle of judicial deference to the agency writing the rule and follow the U.S. Supreme Court precedent of Chevron and most recently the Mayo Foundation decision issued in January of 2011. Accordingly, interaction with the agency now is crucial. (For a discussion of other FDIC rulemakings regarding OLA, please see Pepper Hamilton’s previous Financial Services Alerts, “Pricing Risk: Title II of the Dodd-Frank Act - Orderly Liquidation Authority” (January 11, 2011) and “Updates to Dodd-Frank Rulemaking, Including Orderly Liquidation Authority and Volcker Rule Conformance” (February 18, 2011).

The March 15, 2011 NPR addresses the following issues:

  1. recoupment of compensation from senior executives and directors in accordance with the Act
  2. the definition of a “financial company”
  3. priorities of expenses and unsecured claims
  4. the administrative process for initial determination of claims and the process for judicial determination of claims disallowed by the receiver, and
  5. application of the power to avoid fraudulent or preferential transfers.

Recoupment of Compensation

The NPR establishes criteria under which the FDIC, as receiver, will recoup compensation from persons who are substantially responsible for the failed condition of a covered financial company:

  • The FDIC, as receiver, can recover from any current or former senior executive or director substantially responsible for the failure of such a company any compensation received during the two-year period preceding the date on which the FDIC was appointed receiver. In the case of fraud, no time limit applies.
  • A senior executive or director shall be deemed to be substantially responsible for the failed condition of a covered financial company placed into receivership under OLA if (1) he or she failed to conduct his or her responsibilities with the requisite degree of skill and care required by that position, and (2) as a result, individually or collectively, caused a loss to the covered financial company that materially contributed to the failure of the covered financial company under the facts and circumstances.
  • Substantial responsibility shall be presumed when the senior executive or director is the chairman of the board, chief executive officer, president, chief financial officer, or acts in any other similar role regardless of his or her title if in this role he or she had responsibility for the strategic, policymaking, or company-wide operational decisions of the covered financial company. A person presumed to be substantially responsible may rebut the presumption by proving that he or she performed his or her duties with the requisite degree of skill and care required by the position.

Pepper Point: This NPR has serious implications for the finances of executive officers and directors. Whether this risk can be transferred to an insurance carrier is an important issue to review. The policy appears to seek alignment of insuring executive officers’ and directors’ compensation with long-term rather than short-term shareholder value.

Pepper Point: This NPR may be inconsistent with 12 U.S.C. 1821(k), state law gross negligence standards, business judgment defenses, and the FDIC’s policy on claims it may bring against directors and officers of insured depository institutions (see Financial Institution Letter FIL–87–92 dated December 3, 1992 and Atherton v. FDIC, 519 U.S. 213 (1997)).

Pepper Point: The presumption in the NPR that certain persons are substantially responsible for the failed condition of a covered financial company represents a strong policy by the FDIC to carry out the Act’s goal of ensuring that those responsible for a covered financial company’s demise, not taxpayers, are responsible for covering the costs of the failure. Chairpersons of boards, chief executive officers, presidents, chief financial officers and those who act in similar roles are on notice that they will be presumed to have led to the failure of a covered financial company. Although the presumption of substantial responsibility is rebuttable, it is an intimidating proposition for individuals in these positions to essentially be found liable until proven blameless.

Pepper Point: An open question is whether this will be the exclusive remedy for the FDIC with respect to directors and officers, or whether the FDIC will also have the ability to pursue directors and officers in a manner consistent with what it has done in the past with directors and officers of insured depository institutions.

Financial Company

Under the NPR a financial company may be subject to OLA. A financial company is a company that is determined to be predominantly engaged in financial activities. The NPR defines a company as being predominantly engaged in financial activities if (1) at least 85 percent of the total consolidated revenues of the company for either of its two most recent fiscal years were derived, directly or indirectly, from financial activities; or (2) based upon all the relevant facts and circumstances, the FDIC determines that the consolidated revenues of the company from financial activities constitute 85 percent or more of the total consolidated revenues of the company.

The NPR also defines a financial activity. A financial activity includes (1) any activity, wherever conducted, described in section 225.86 of Regulation Y1 or any other successor regulation; (ii) ownership or control of one or more depository institutions; and (iii) any other activity, wherever conducted, determined by the Federal Reserve Board in consultation with the Secretary of the Treasury, under the Bank Holding Company Act, to be financial in nature or incidental to a financial activity.

Pepper Point: The NPR provides some clarity as to what qualifies as a financial company. The NPR does, however, give the FDIC some leeway for determining whether an organization is a financial company as a result of the “based upon all relevant facts and circumstances” language. Organizations that could be classified by the FDIC, and counterparties to such organizations, should understand the potential ramifications of OLA for a covered financial company, especially those senior executives potentially subject to recoupment of compensation by the FDIC as receiver.

Priority of Expenses and Unsecured Claims

The NPR establishes a comprehensive framework for the priority payment of creditors. The NPR lists each of the 11 priority classes of claims established under the Act in the order of relative priority: (1) claims with respect to post-receivership debt extended to the covered financial company where such credit is not otherwise available; (2) other administrative costs and expenses; (3) amounts owed to the United States; (4) wages, salaries and commissions earned by an individual within 6 months prior to the appointment of the receiver up to a certain amount; (5) contributions to employee benefit plans due with respect to such employees up to a certain amount; (6) claims by creditors who have lost setoff rights by action of the receiver; (7) other general unsecured creditor claims; (8) subordinated debt obligations; (9) wages, salaries and commissions owed to senior executives and directors; (10) post-insolvency interest, which shall be distributed in accordance with the priority of the underlying claims; and (11) distributions on account of equity to shareholders and other equity participants in the covered financial company.

Administrative Claims Process and Judicial Determination of Disallowed Claims

The NPR also establishes procedures for filing a claim with the FDIC as receiver and, if dissatisfied with the FDIC’s resolution of the claim, pursuing the claim in court. Generally, the process calls for creditors to file claims with the FDIC as receiver by a claims bar date. The receiver will then determine whether to allow the claim within 180 days. If the claim is disallowed the claimant may seek judicial review of the claim by filing a lawsuit within 60 days. The claimant must exhaust the administrative claims process as a jurisdictional prerequisite before any court can adjudicate the claim. The NPR also notes that the administrative claims process under OLA is closely modeled after the claims process set forth in the Federal Deposit Insurance Act for receiverships of insured depository institutions.

Avoidance of Fraudulent or Preferential Transfers

The NPR addresses the power of the FDIC as receiver to avoid certain fraudulent and preferential transfers and seeks to harmonize these powers with analogous provisions in the U.S. Bankruptcy Code. The NPR notes two potential areas for inconsistent treatment of transferees under OLA as compared to the Bankruptcy Code. The first relates to whether the FDIC as receiver can avoid a transfer as fraudulent or preferential. The NPR makes it clear that the FDIC could not, under OLA, avoid as preferential the grant of a security interest perfected by the filing of a financing statement in accordance with the provisions of the Uniform Commercial Code or other non-bankruptcy law where a security interest so perfected could not be avoided in a case under the Bankruptcy Code.

The second issue relates to a 30-day grace period in the avoidance provisions under the Bankruptcy Code. The Act does not contain any such express grace period. Consistent with the direction in the Act to harmonize OLA regulations with otherwise applicable insolvency law to the extent possible, the NPR indicates that the avoidance provisions in the Act would apply the 30-day grace period as provided in the Bankruptcy Code, including any exceptions or qualifications contained therein.