Let's Make Wall Street Execs Pay for Cleaning Up the Mess They Made

By Sam Pizzigati, Too Much: A Commentary on Excess and Inequality. Posted October 16, 2008.

Dig deep enough into the Wall Street bailout bill enacted earlier this month and you'll find a clause that lets a bailed-out bank recover any previously awarded executive "bonus or incentive compensation" that turns out to have been based on statements of enterprise earnings "later proven to be materially inaccurate."

In other words, if a bank CEO has cooked the books to trigger a huge personal payoff, the bank can "claw back" that windfall.

"Clawbacks" have been around for some time now. The reform legislation Congress passed after the Enron debacle, the 2002 Sarbanes-Oxley Act, features a clawback. Individual corporations have also been sticking clawback provisions in the compensation contracts they cut with executives.

One survey, released last March, found that 28 of the nation's top 30 companies can now claw back pay from executives who have played fast and loose with company earnings statements.

But all these clawback clauses, with a few exceptions, have done next to nothing to put a dent on the mega millions top executives have pocketed over recent years, mainly because companies have to show significant "misconduct" on an executive's part before they can claw back anything. That's not easy. And, more to the point, outright legal misconduct by executives only accounts for a small portion of the immense pay packages that have been going to America's top executives.

San Diego State economist David DeBoskey, a former corporate chief financial officer, estimates that the top five executive officers alone at the banks, insurers, mortgage brokers, and other financial firms likely to benefit from the Wall Street bailout collected a combined $27 billion in compensation from 2003 through 2007.

Add in the bonus billions that went to power-suits below the top-five level, and this total mounts much higher. All these execs didn't make their billions -- for the most part -- by cooking books. They made their fortunes taking reckless risks. The clawback provisions now on the books, unfortunately, won't recoup a dime from any of this recklessness. Does all this make clawbacks an over-hyped deadend? Some analysts don't think so. Appropriately reconfigured, they feel, clawbacks could be an important tool for attacking the concentration of income and wealth at America's economic summit.

One of these analysts, veteran Massachusetts attorney E. Michael Thomas, believes that a clawback offensive could help fund a substantial share of the Wall Street bailout. Thomas is proposing that any firm receiving bailout dollars should be subject to the "clawback of executive incomes, management fees, or stock options for the prior seven years, to the extent necessary to fund that company's bailout."

The key to the Thomas clawback approach: a political willingness to apply the "polluter pays" principle from existing environmental law to the bailout.

In the 1970s, Thomas notes, lawmakers had to decide how to pay for cleaning up the nation's toxic waste dumps. They decided that they weren't going to waste taxpayer dollars trying to prove individual enterprises at fault. Instead, they would operate under the principle that any enterprise that derived economic benefit from dumping waste at a site would be expected to help pay for the site's clean-up.

That same principle could be applied, via clawbacks, to the Wall Street bailout. These clawbacks, says Thomas, wouldn't require "an assessment of guilt or culpability" on any one executive's part.

"Instead," explains Thomas, a past recipient of the EPA's top public service award, "the clawbacks would reflect the simple policy judgment that the executives who derived economic benefit from creating the conditions that necessitated the bailout should pay for it."

Such an approach to the Wall Street bailout, adds Thomas, a knowledgeable venture capital attorney, would strike many players in high-finance as eminently familiar.

Back during the days of the dot.com boom, the general partners of venture capital firms raised billions of dollars from investors for stuffing into fledgling -- and often flaky -- Internet companies. Those investors with smart lawyers insisted on clawback clauses that gave them the right to extract refunds -- if their investments went sour -- out of the management fees and bonuses that went to the general partners.

Many of those investments did go sour as "sure-thing" dot.com business plans failed to "monetize." Venture capitalists ended up foregoing their management fees -- and even coughing up their annual bonuses from previous years.

Similar clawbacks, says Thomas, should now bankroll the Wall Street bailout.

"The executives who won big in Wall Street's conveniently unregulated casino games," he advises, "should be made to disgorge out of their own pockets, just like venture capital general partners had to do when the dot.com bubble popped."

Treasury Secretary Henry Paulson seems to be running, as fast as he can, the other way. Financial industry executives, the New York Times reports, have "begged Mr. Paulson not to impose tough restrictions on executive pay and golden-parachute deals for executives who are fired." Paulson, says the Times, has "heeded those pleas."

See more stories tagged with: ceo, wall street, bailout, financial crisis, clawback

Sam Pizzigati is the editor of the online weekly Too Much, and an associate fellow at the Institute for Policy Studies.

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