D&O Insurance to Cover Clawbacks -- Should it be Legal?

The Dodd-Frank Bill, signed into law by President Obama last year, makes significant changes to the financial services industry. It was written and passed in response to the financial services crisis of 2008-2009. It's upward of 2000 pages, and frankly, it's not an interesting read. Lots of the stuff in there only adds to the bureaucracy and frankly, will do nothing that was intended by the bill. That is, either it puts no teeth in penalties, or it is disclosure that has value roughly equivalent to the yen right after World War II. Readers may recall that I have ranted several times about the dreaded pay ratio disclosure in Dodd-Frank Section 953(b). To me, that is the ultimate example of uselessness in Dodd-Frank.

Among the more controversial provisions are the clawback rules in Dodd-Frank. Without going into gory detail, a clawback is the required repayment of certain items of compensation when an organization goes into significant financial stress (usually bankruptcy) or when the organization's financial statements contain material misstatements. Under Dodd=Frank, in certain of those circumstances, there is a rebuttable presumption that such events are the fault of the CEO, CFO, and Chairman of the Board unless they can demonstrate otherwise. In such cases, compensation may be clawed back for several years.

Many find this rule to be draconian. Others find it to be uninforceable as the executives may no longer have those amounts. Who will pay them in those cases?

While it may not be readily enforceable, to me, the intent of this rule is correct. If you are the CEO, CFO, or Chairman of such an organization, you should have had some control over the events that occurred. If you didn't, then barring very unforeseen circumstances, it is highly likely that one could argue that you were asleep at the wheel. (I'll grant that there are circumstances such as natural disaster whose damage far exceeds any insurable limits. But, in those circumstances, I would hope that the presumption of guilt could be rebutted successfully.) If that happens, then it seems right to me that your incentive compensation should be clawed back.

Now there are insurance brokers who are looking to make money off of this. And, frankly, I don't blame the brokers. They are in business to make money, and what they are doing seems to be legal. But, should it be?

What they are doing is selling Directors and Officers Insurance (D&O) to insure against such occurrences.As I said, this appears to be perfectly legal. I don't think it should be. You just should not be allowed to insure yourself against your own malfeasance or fraud. If you can, then there is suddenly no penalty for bad behavior.

To me, this is a disturbing trend. While I am rarely one to ask for more government intervention, here, in my opinion, it is sorely needed.