AIG Defers To The Compensation Czar

AIG has another $2.4 million wave of retention bonuses to pay out. But this time, rather than anger pretty much the entire world, they decided to pass the buck to Kenneth Feinberg, the Obama administration's Special Master for Compensation (yes, that's really his title). This sets up a fascinating situation: will the administration pay out those bonuses or will it refuse?

CNN Money provides some information from an unnamed source, and a bit of detail:

A source close to the matter said Feinberg will be reviewing both the $2.4 million, as well as the much more controversial $235 million that is scheduled to be paid out AIG-FP employees next year.

AIG-FP is the division that wrote insurance contracts on shaky derivatives that were at the root of the company's near-collapse. In September, the government bailed out AIG with funds now worth up to $182 billion.

Fireworks! I can hardly wait to see what the almighty pay czar decides. On one hand, it seems pretty intuitive that some of those bonuses, particularly those for the AIG-FP division, are not particularly deserved, under the circumstances. Yet, the contracts are legally binding. So those employees could sue AIG/Uncle Sam to recover those bonuses if they are denied payment.

Angry taxpayers' first inclination might be to say: let 'em try! Sure, but then we still incur the cost of lawyers defending Feinberg's decision. Would the cost of that legal defense be as much as the $235 million owed in bonuses? Probably not, but it wouldn't be cheap. So Feinberg should seek a better way to recover bonuses.

Here are a few options I think he could consider:

Impose That Excise Tax

Remember back in March when Congress was so angry about the AIG bonuses paid out? The House passed legislation meant to recoup all of that money. That legislation sought to impose an excise tax specifically targeted at those bonuses. Yet, their legislation turned out to be largely symbolic: the Senate never passed it, and President Obama never got the opportunity to sign it.

But what if they resurrected it, and then paid out the bonuses as scheduled? I wrote an article about Congress' scheme at that time, back when I was at Forbes. There was some debate then about whether the legislation was constitutional. That debate would likely resurface, but in writing the article, I spoke to renowned Harvard Law School professor Laurence Tribe. Here's what I learned from Tribe:

The constitution would not preclude an excess tax for a specific group of individuals at a very high rate. Moreover, Tribe argues, the taxes are not meant to be outwardly punitive--the purpose is to recover bonuses paid as part of federal expenditures, not to punish employees.

Its retroactive nature won't matter either. "The Supreme Court has, in numerous cases going back to the 1920s, upheld tax measures that claw back amounts prior to the effective date of the enactment," says Tribe.

I should mention that the excise tax only applied to employees at firms receiving government aid. Frankly, it seems kind of okay with me that if you tango with the government rescuing your company, you could get dipped.

Pay Them In AIG Options

If Feinberg wants to get really cute, he can pay the bonuses out -- in AIG options, with the strike price the stock value when the bonus contracts were signed. I mean that if you were owed a bonus of $100,000 then you get 1000 option contracts with a $100 strike price, if that was the stock price of AIG when your contract was originally written.

That would likely end up costing the taxpayers very, very little money. And if those employees continue to work hard and bring AIG back to life, then maybe they can make those options worth something and eventually get those bonuses.

Sure, the employees would likely sue. But then they'd be left the dubious task of arguing in court that they didn't want stock options that they made worthless by driving their firm into ground.

Think Bankruptcy

If the government hadn't intervened in AIG, it would have gone bankrupt. If it had gone bankrupt, would those employees' bonuses have been paid out in bankruptcy court? Beats me. So I consulted a bankruptcy attorney, Gary Jacobson of Herold Law, P.A. He tells me that it depends on whether or not AIG chose to keep those employees on after bankruptcy (assuming Chapter 11).

During bankruptcy proceeds, AIG could have "rejected" those contracts. At that point, those employees could have either chosen to leave or negotiated new contracts from scratch. Jacobson says:

Bankruptcy would enable AIG to reduce any claim for a future bonus to a general unsecured claim, but with no assurance that its employee could be induced to stay with the company.

Of course, that isn't what happened, but I had a thought. What if Congress passed legislation saying, if a firm agrees to government assistance, then its employees' contracts can be treated as they would under bankruptcy? After all, those companies would have gone into bankruptcy without government assistance anyway. And here's the kicker -- the government can decide the fate of those contracts.

This would have a few effects. First, if they really did need to retain those guys, they could draw up new contracts, probably with toned down bonus payments. Second, the legislation would likely deter firms from seeking government bailouts in the future. I don't know about you, but a world where no firm ever sought a government bailout is one where I would like to live.