In proposing incentive compensation clawback rules, the Securities and Exchange Commission studiously ignored any constitutional restraints on its actions.  Buried in the 198-page proposal is this chilling assertion:

Issuer compliance would be required whether such incentive-based compensation is received pursuant to a pre-existing contract or arrangement, or one that is entered into after the effective date of the exchange’s listing standard.

Does the SEC have the authority to interfere with private, pre-existing contracts?

All About Omnia

The federal government, unlike the states, is not subject to the Impairment of Contract Clause found in Article 10, Section 1 of the United States Constitution (“No State shall . . . pass any . . . Law impairing the Obligation of Contracts.”).  Pension Benefit Guaranty Corp. v. Gray & Co., 476 U.S. 717, 733 (1984).  The primary check on Congress’ power to interfere with contracts between or among private parties is the Takings Clause found in the Fifth Amendment to the United States Constitution (“nor shall private property be taken for public use, without just compensation”).

Justice George Sutherland established the test for when Congressional action might constitute a prohibited takings over ninety years ago in Omnia Commercial Co., Inc. v. U.S., 261 U.S. 502 (1923).  That case involved a contract to buy steel from the Allegheny Steel Company at a below-market price.  Following the United States’ entry into World War I, the federal government requisitioned all of Allegheny’s steel for the war effort.  The buyer sued, but the Supreme Court held that there was no remedy for consequential damages arising from lawful governmental action.  According to the Supreme Court, a remedy exists for federal impairment of a contract only when the action is targeted directly at the contract itself.

There can be no serious question that the SEC’s proposed rules are targeted at pre-existing contracts.  There is also no doubt that a contract constitutes property for purposes of the Takings Clause.  U.S. Trust Co. v. New Jersey, 431 U.S. 1, 19 n.16 (1977).  However, it is probably more appropriate to view the proposed rules as appropriate money directly from individuals.  If applied to pre-existing contracts, the taking is all the more stark because of the no fault nature of the statute and the proposed rules.