D&O Insurer Offers Clawback Protection

The Federal Deposit Insurance Corp. adopted new rules in July allowing it to claw back up to two years of pay from officers and directors at financial firms found to have contributed to the failure of the firm, and already executives are looking for ways to circumvent it.

Now one company might have a solution: clawback insurance.

Insurance broker and risk advisory firm Marsh is offering coverage to protect directors and officers of non-bank financial organizations against the compensation clawback provision adopted by the FDIC under the Dodd-Frank Act. In addition to the regular coverage of legal expenses and settlements by directorsand- officers insurance, Marsh is offering an add-on to cover the compensation of insured executives as well.

Mark Cuoco, managing director at Marsh's financial and professional liability division, says the insurance, FDIC Receivership Endorsement, was created to protect senior executives and directors who are likely to be hit by the Dodd- Frank provision that allows the FDIC to recoup directors and executives' compensation for causing the failure of a company. "Specifically, we are looking to insure the risks as highlighted in Section 210" of the law, he says.

Under Title II of Dodd-Frank, Section 210 dictates the FDIC's authority to recoup compensation from any senior executives or directors found to be responsible for the failure of any covered financial companies, either through fraudulent activities or negligence. The rule allows the FDIC to claw back compensation for the two years prior to a firm's failure, and gives the FDIC the authority to pursue additional claims against senior directors and executives.

Cuoco says the Dodd-Frank provision has significantly expanded FDIC power to recoup pay. FDIC Receivership Endorsement promises to cover the costs and attorney fees incurred by executives during any actions brought by the agency, as well as reimburse any lost salary or other damages arising from non-intentional wrongful acts by executives. The insurance also protects the personal assets of executives and directors of financial companies. "The insurance will compensate any claims that are legally permissible," he says.

Marsh says it has sold the policies to professionals at dozens of non-bank fi- nancial firms such as hedge funds, alternative investment funds, private equity firms, and venture capital firms, although it declined to name any. "In order for the insurance to pay, the failure of the organization has to cause systemic risk in the market. Officers of these companies are eligible to be insured," Cuoco says. Other insurance companies are also expected to begin offering the expanded coverage.

No firms have filed claims under Marsh's FDIC policies so far. Policies are priced based on the financial conditions of individual companies determined by the performance and quality of corporate governance of each individual firm, Cuoco says.

Is It Legal?

Compensation clawbacks were first introduced in the Sarbanes-Oxley Act of 2002. Under SOX, recoupment applies only to chief executives and chief financial officers and to fraud cases discovered within a one-year period. In contrast, the FDIC's rule under Dodd-Frank applies to anyone who fails to carry out their responsibilities as required by his or her position, which then leads to the failure of a covered financial company. (A separate Dodd-Frank rule will require all public companies to adopt a clawback policy for executive pay earned thanks to financial performance that later is proven to be erroneous.)

Marsh's new product is not without controversy. Experts say the purpose of adopting the rule is to hold executives accountable for their actions; eliminating that risk through insurance coverage defeats that purpose. They agree, however, that selling such clawback insurance appears to be legal.

"The insurance business is all about selling products to cover risks. Since compensation recoupment poses business and personal risks to those involved, it is a legal coverage if you can get it," says Robert Chesler, chair of group insurance at law firm Lowenstein Sandler. He says insurance companies can sell these types of products, since the clawback provision is viewed as a risk to executives. "There is nothing in the Dodd-Frank Act which prohibits the sale of such insurance coverage," he says.

In addition, neither the FDIC nor the Securities and Exchange Commission has the authority to interfere with insurance companies' abilities to draw contracts with executives on any risks they want to cover. If the insurance is tied to the coverage on loss of personal property of the executives, insurance companies can definitely sell a product to mitigate that risk. "If it is losses that the insurance is covering, they can definitely do that," Chesler says.

Historically, he adds, the insurance industry does not cover deliberate wrongdoing, but companies can protect themselves against negligence. Chesler says the standard in the insurance industry has always been not to compensate outright fraud. "If it is negligence, then the insurance provider can definitely reimburse the insured," he says.

It will be up to the FDIC and SEC to challenge the legality of such products, says Michael Melbinger, chair of employee benefits and executive compensation practice at law firm Winston and Strawn. "They have to determine if such insurance is in violation of public policy," he says.

At the moment, he says, no law prohibits the sale of the insurance, particularly if the officers and directors buy the insurance with their own money. "It is just like buying insurance on your car or house, no government can prohibit you from insuring personal risks," Melbinger says.

Marsh would not say if it was considering expanding the coverage to officers and directors at all companies that will be subject to the broader clawback provision in Dodd- Frank. (The deadline for the SEC to finalize rules on the executive compensation clawback provision has been postponed to between January and June of next year.)

Chesler says although the concept of pay clawback insurance is interesting, it is still too early to assess the degree of coverage offered by the new product. "It really will all depend on how Marsh will reimburse its first claimant," he says. If the first claim reimbursement fails to live up to its hype, Chesler says, it may just end up being another type of D&O insurance in the market.

MARSH FDIC RECEIVERSHIP POLICY

Below is an excerpt from Marsh regarding key points of its FDIC Receivership Claims coverage:

FDIC Receivership Risks Created by the Dodd-Frank Act

Under Title II of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act), the Federal Deposit Insurance Corporation (FDIC) may be appointed the receiver of a financial company with or without the acquiescence of the financial company's board of directors. Once appointed, the FDIC may:

* Issue subpoenas requiring individual executives to produce documents and information that the FDIC deems necessary to the orderly liquidation of the financial company.

* Repudiate any contracts entered into before the FDIC became receiver that it determines to be "burdensome," including compensation agreements.

* Recoup any compensation received during the previous two year period by any current or former senior executive or director that the FDIC deems "substantially responsible for the failed condition" of the financial company.

* Directly and personally sue directors and officers for monetary damages for gross negligence and disregard of duty of care.

To be clear, even compensation received by a senior executive up to two years prior-likely already spent or reinvested-can still be recovered by the FDIC, even if the executive or director engaged in no fraud or criminal behavior.

Marsh's First-Of-Its-Kind FDIC Receivership Protects Personal Assets

Executives and directors of financial companies can protect their personal assets even in the face of this broad authority. Marsh has collaborated with two of the world's most respected insurers to create first-of- its kind insurance coverage that funds the defense of and damages for such actions by the FDIC. Specifically, the coverage will pay up to the policy's limit of liability for the following:

* Costs and attorneys fees incurred by an executive or director in evaluating, responding to, and defending against any subpoena, written request or notice, written demand, complaint, or similar documents received from the FDIC.

* Earned salaries, wages, commissions, benefits, and any other compensation either repudiated or "clawed back" by the FDIC from an executive or director.

* Damages established by the FDIC due to non- intentional wrongful acts or omissions by the executive or director.

Source: Marsh FDIC Receivership Fact Sheet.

"In order for the insurance to pay, the failure of the organization has to cause systemic risk in the market. Officers of these companies are eligible to be insured."

-Mark Cuoco, Managing Director, Marsh Insurance