Complex Conflicts of Interest & the Problem of the HNW Cabinet

It’s been reported that the incoming cabinet, if confirmed, would be the wealthiest ever. I haven’t checked the math on that one; Andrew Mellon was one of the three or four richest Americans in 1921 when he joined the Harding administration. In any event, it’s almost certainly the case that the President-elect and his nominees have the most complex bundle of assets ever held by a group of high executive officials. The complexity of many of these individuals’ past economic lives makes assessing their potential financial conflicts remarkably difficult, to a degree that I think most people have not focused on.

Incoming government officials are required to divest themselves of direct financial conflict, and there is a tax statute, section 1043 of the Code, that allows deferral of built-in gains to facilitate that process. Alternately, the official must recuse herself from any decision affecting her financial interests, other than “remote” or “insubstantial” effects.

These conflict analyses generally focus on equity and other security interests, but many individuals of very high net worth have economic exposure in a variety of other ways that don’t seem to have drawn much attention.

Most straightforwardly, there seems to be no obvious way for some individuals to divest themselves of liability or other retrospective claims. Just to pick one area near to my heart, foundation insiders can be personally liable for acts of self-dealing by the foundation.

Likewise, Dodd-Frank includes a clawback provision for executive compensation in the case of certain adverse firm events. Conceivably, incoming officials might be sent to Lloyd’s of London to purchase insurance against some of these outcomes, although any co-insurance would leave questions about whether the remaining exposure was “substantial” under the statute.

Another area that seems under-examined is pensions. In a typical executive pension, such as the ones Vice-President Cheney and SEC Chair Mary-Jo had, and which nominees Mnuchin, De Vos, and Tillerson almost certainly have, the executive is effectively a creditor of the firm. For tax reasons, an executive pension usually is funded out of assets that remain subject to the claims of the firm’s creditors (because that arrangement allows tax on the payment to be deferred under cash-out). This means that, if the firm goes bankrupt, or even approaches the zone of insolvency, the executive could lose all or a large portion of her retirement nest-egg.

Past divestments don’t seem to have accounted for this. For example, Chairman White’s ethics letter reported that she would suspend payments from her law firm pension while in office. But White, as SEC chair, had the power to take actions that conceivably could have threatened the ongoing liquidity of her firm, and therefore her claim (contingent on that very liquidity) to a lifelong stream of annuity payments.

I guess there’s a question about whether contingent pension claims are “remote.” Could Secretary Tillerson make decisions that could affect the likelihood that Exxon would live to pay retiree Tillerson his pension? For sure, but Exxon currently is a long way from the zone of insolvency. But a decision that increases the odds of insolvency before Tillerson’s death from, say 1% to 15% (e.g., a global agreement to tax carbon)? “Remote”?

What do you say, readers? E-mails welcome.

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