Clawback

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The term clawback or claw back refers to any money or benefits that have been given out, but are required to be returned (clawed back) due to special circumstances or events, such as the monies having been received as the result of a financial crime, or where there is a clawback provision in a contract. [1] [2]

Contents

Financial crime clawbacks

Clawbacks lawsuits in US courts, especially from innocent individuals and entities who profited from financial crimes of others, have increased in the years since 2000. [3] In its article "The Amazing Madoff Clawback; How two lawyers, Irving Picard and David Sheehan, have recovered 75 cents on the dollar of the stolen money—many times the usual rate in such cases," The Wall Street Journal discussed how Irving Picard has headed a team of lawyers that have clawed back an unprecedented 75% of the monies illegally taken by Bernard Madoff, by filing suits to claw back monies from those who profited from the scheme, whether they knew of the scheme or not. [4] [5] [6] [3] Kathy Bazoian Phelps, a lawyer at Diamond McCarthy, said "That kind of recovery is extraordinary and atypical,” as clawbacks in such schemes range from 5 percent to 30 percent, and many victims don’t get anything. [5] Picard has successfully pursued clawbacks from not only investors, but spouses and estates of those who profited, such as the wife of Bernard Madoff (Ruth Madoff), and the estate of the deceased Jeffry Picower and Picower's wife Barbara, with whom he reached a $7.2 billion settlement (the largest civil forfeiture payment in US history). [5] [7] [8]

Irving H. Picard is a partner in the law firm BakerHostetler. He is known for his recovery of funds in the Madoff investment scandal from investors, Bernie Madoff and his family, and their spouses and estates.

Ruth Madoff is the wife of Bernie Madoff, the convicted American financial fraudster who is serving a prison sentence for a criminal financial scheme. After her husband's arrest for his fraud, she and her husband attempted suicide in 2008. While she had $70 million in assets in her name, after her husband was sentenced she was stripped of all of her money other than $1-2 million, by the government and by the trustee for her husband's firm, Irving Picard.

Jeffry M. Picower was an American investor involved in the Madoff investment scandal. He was the largest beneficiary of Madoff's Ponzi scheme, and his widow agreed to have his estate settle the claims against it by Madoff trustee Irving Picard for $7.2 billion, the largest single forfeiture in American judicial history.

Faithless servant clawback

Under the faithless servant doctrine, an employee who commits a crime in his work or fails to follow the company code of conduct or code of ethics is subject to having all of his compensation clawed back by the employer. In Morgan Stanley v. Skowron, 989 F. Supp. 2d 356 (S.D.N.Y. 2013), applying New York's faithless servant doctrine, the court held that a hedge fund's portfolio manager engaging in insider trading in violation of his company's code of conduct, which also required him to report his misconduct, must repay his employer the full $31 million his employer paid him as compensation during his period of faithlessness. [9] [10] [11] [12] The court called the insider trading the "ultimate abuse of a portfolio manager's position." [10] The judge also wrote: ""In addition to exposing Morgan Stanley to government investigations and direct financial losses, Skowron's behavior damaged the firm's reputation, a valuable corporate asset." [10]

The faithless servant doctrine is a doctrine under the laws of a number of states in the United States, and most notably New York State law, pursuant to which an employee who acts unfaithfully towards his employer must forfeit all of the compensation he received during the period of his disloyalty.

Clawback provision

A clawback provision is a contractual clause typically included in employment contracts by financial firms, by which money already paid to an employee must be paid back to the employer under certain conditions. The term also is in use in bankruptcy matters where insiders may have raided assets prior to a filing, [13] and in Medicaid, when a state recovers costs of long-term care or covered medical expenses from the estates of deceased Medicaid patients. The aim of the clause is to secure an option for an employer or trustee to limit bonuses, compensation, or other remuneration in case of catastrophic shifts in business, bankruptcy, and national crisis such as the financial crisis of 2007–2008, and for states to recoup the cost of administering Medicaid services.

Bankruptcy legal status of a person or other entity that cannot repay the debts it owes to creditors

Bankruptcy is a legal process through which people or other entities who cannot repay debts to creditors may seek relief from some or all of their debts. In most jurisdictions, bankruptcy is imposed by a court order, often initiated by the debtor.

Financial crisis of 2007–2008 Global financial crisis

The financial crisis of 2007–2008, also known as the global financial crisis and the 2008 financial crisis, is considered by many economists to have been the most serious financial crisis since the Great Depression of the 1930s.

The employees' bonuses are, in a clawback scheme, tied specifically to the performance (or lack thereof) of the financial product(s) the individual(s) may have created and/or sold as part of his or her job expecting a high profit. If the product does indeed do well over a long period of time, and permanently improves the nature of the firm, the bonuses paid to the individual are allowed to be retained by the individual. However, if the product fails, and damages the nature of the firm—even years down the line from the product's inception—then the firm has the right to revoke, reclaim, or otherwise repossess some or all of the bonus amount(s). [14] However, research shows managers who are subject to clawback provisions that are newly in place in a company often try to offset their increased risk of bonus clawback by demanding an increase in base salary that is not subject to being clawed back. [15]

The prevalence of clawback provisions among Fortune 100 companies increased from lower than 3% prior to 2005, to 82% in 2010. [16] The growing popularity of clawback provisions is likely, at least in part, due to the Sarbanes-Oxley Act of 2002, which requires the U.S. Securities and Exchange Commission (SEC) to pursue the repayment of incentive compensation from senior executives who are involved in a fraud. In practice, the Securities and Exchange Commission has enforced its clawback powers in only a small number of cases. [17]

U.S. Securities and Exchange Commission Government agency

The U.S. Securities and Exchange Commission (SEC) is an independent agency of the United States federal government. The SEC holds primary responsibility for enforcing the federal securities laws, proposing securities rules, and regulating the securities industry, the nation's stock and options exchanges, and other activities and organizations, including the electronic securities markets in the United States.

The Dodd-Frank Act of 2010 mandates that the SEC require that U.S. public companies include a clawback provision in their executive compensation contracts that is triggered by any accounting restatement, regardless of fault (whereas the clawback provisions per the Sarbanes-Oxley Act only applied to intentional fraud). As of mid-2015, this portion of the Dodd-Frank Act had yet to be implemented. [18]

Implications

The usual objective of a clawback provision is to deter managers from publishing incorrect accounting information. Academic research finds that voluntarily adopted clawback provisions appear to be effective at reducing both intentional and unintentional accounting errors. [15] The same study also finds that investors have greater confidence in a firm's financial statements after clawback adoption, and that boards of directors place greater weight on accounting numbers in executive bonuses after a clawback is in place (i.e., pay for performance sensitivity increases).

According to a December 2010 New Yorker magazine article, [14] the clawback phenomenon pursued by banks and other financial groups directly and/or indirectly responsible for the financial crisis has been used by the chief administrators of those institutions in order to make the case that they are presently taking tangible self-corrective action to both prevent another crisis (by supposedly dis-incentivizing the sorts of shady investment-product behavior displayed by their people in the past) and to appropriately punish any potential future activity of a similar sort. However, the case is made in The New Yorker article (which cites several professional economists who agree with its perspective) that it is probably unlikely that either result will become the case, and The New Yorker article also suggests that the people making this argument may not even truly believe it, but are instead promoting it as a sort of public relations tactic until such time as the impact of the financial crisis fades and similar (perhaps near-identical) abuses of the financial system can slowly and quietly resume, with minimal or no detection by outside forces. [14]

Background

In the past, clawback phenomena have been used primarily in securing tax incentives, abatements, tax refunds, and grants. Clawbacks are distinguished from repayments or refunds as they involve a penalty, in addition to a repayment.

The use of tax incentives for attracting jobs and capital investment has grown over the past decades to include performance measures from which to gauge a company's growth. Typical measures are:

  1. number of created jobs over 5 or 10 years;
  2. annual payroll;
  3. amount of capital investment over a similar time frame; and
  4. amount of depreciated value in a given time.

More unusual measures are retaining a headquarters at a specific site for a period of time, amount of production increase or production cost decrease per unit, or the requirement to bring a given technology to a commercial market. The recipient will be required to return the monetary value of the incentive plus a penalty and/or interest to the grantor of the incentive, usually a local or state taxing authority. As the use of incentives mature over time, it is sometimes alleged [ who? ] that the triggering of clawbacks for non-performance will likely become more ubiquitous.

Clawbacks can be understood to be the contractual elements that stand between the drive for economic development and community development and the slippery slope of corporate welfare. They are highly controversial and are utilized as community-based guarantees for some expectation of performance. The site location industry normally tries to eliminate or reduce any such promises as part of their negotiations. [19] [20] [20] [21]

Mortgage brokering clawbacks

Clawbacks are also used by most banks and lenders to recover money from "unprofitable" home loans. This is usually done when the borrower pays back the loan in a short period of time, usually within 24 months of the loan advancement.

In Australia, this fee is usually 0.77% of the total loan amount for loans paid back within the first 12 months after the settlement, and 0.385% within 24 months. If a borrower is using a mortgage broker for their home loan, then the broker will usually charge them this amount.

In various countries

Italy and the Netherlands have several clawback regimes, and there are two clawback regimes in the United Kingdom. [22] The French clawback regime is limited. [22] In Beligium, their enforceability is unclear. [22]

Related Research Articles

In the United States, a 401(k) plan is the tax-qualified, defined-contribution pension account defined in subsection 401(k) of the Internal Revenue Code. Under the plan, retirement savings contributions are provided by an employer, deducted from the employee's paycheck before taxation, and limited to a maximum pre-tax annual contribution of $19,000.

Sarbanes–Oxley Act United States law covering finance and accountability

The Sarbanes-Oxley Act of 2002, also known as the "Public Company Accounting Reform and Investor Protection Act" and "Corporate and Auditing Accountability, Responsibility, and Transparency Act" and more commonly called Sarbanes–Oxley, Sarbox or SOX, is a United States federal law that set new or expanded requirements for all U.S. public company boards, management and public accounting firms. A number of provisions of the Act also apply to privately held companies, such as the willful destruction of evidence to impede a federal investigation.

Workers compensation insurance for injuries during employment, in exchange for relinquishing the right to sue the employer

Workers' compensation is a form of insurance providing wage replacement and medical benefits to employees injured in the course of employment in exchange for mandatory relinquishment of the employee's right to sue their employer for the tort of negligence. The trade-off between assured, limited coverage and lack of recourse outside the worker compensation system is known as "the compensation bargain". One of the problems that the compensation bargain solved is the problem of employers becoming insolvent as a result of high damage awards. The system of collective liability was created to prevent that, and thus to ensure security of compensation to the workers. Individual immunity is the necessary corollary to collective liability.

Principal–agent problem Agency Problem

The principal–agent problem, in political science and economics occurs when one person or entity, is able to make decisions and/or take actions on behalf of, or that impact, another person or entity: the "principal". This dilemma exists in circumstances where agents are motivated to act in their own best interests, which are contrary to those of their principals, and is an example of moral hazard.

Fred Wilpon is an American real estate developer, baseball executive, and the majority owner of the New York Mets.

Performance-related pay or pay for performance, not to be confused with performance-related pay rise, is a salary or wages paid system based on positioning the individual, or team, on their pay band according to how well they perform. Car salesmen or production line workers, for example, may be paid in this way, or through commission.

Schulte Roth & Zabel, LLP is a full service law firm with offices in New York, Washington, D.C., and London.

BakerHostetler is an American 1,000-attorney law firm founded in 1916. One of the firm's founders, Newton D. Baker, was U.S. Secretary of War during World War I, and former Mayor of Cleveland, Ohio.

The Troubled Asset Relief Program (TARP) is a program of the United States government to purchase toxic assets and equity from financial institutions to strengthen its financial sector that was passed by a Democratic Party controlled Congress and signed into law by Republican Party President George W. Bush on October 3, 2008. It was a component of the government's measures in 2008 to address the subprime mortgage crisis.

Bernie Madoff American former businessman, stockbroker, investment advisor, financier and white collar criminal

Bernard Lawrence Madoff is an American former market maker, investment advisor and financier who is currently serving a federal prison sentence for offenses related to a massive Ponzi scheme. He is the former non-executive chairman of the NASDAQ stock market, the confessed operator of the largest Ponzi scheme in world history, and the largest financial fraud in U.S. history. Prosecutors estimated the fraud to be worth $64.8 billion based on the amounts in the accounts of Madoff's 4,800 clients as of November 30, 2008.

Madoff investment scandal Investment scandal discovered in 2008

The Madoff investment scandal was a major case of stock and securities fraud discovered in late 2008. In December of that year, Bernie Madoff, the former NASDAQ Chairman and founder of the Wall Street firm Bernard L. Madoff Investment Securities LLC, admitted that the wealth management arm of his business was an elaborate multi-billion-dollar Ponzi scheme.

Participants in the Madoff investment scandal

Investigators are looking for other participants in the Madoff investment scandal besides Bernard Madoff, despite Madoff's assertion that he alone was responsible for the large-scale Ponzi scheme.

There have been attempts for the recovery of funds from the Madoff investment scandal. As of October 2018, the Madoff Trustee, Irving Picard, reported recoveries and settlement agreements of $13.294 billion, of which $11.275 billion had been distributed or committed to victims of Bernard Madoff.

Accounting scandals are business scandals which arise from intentional manipulation of financial statements with the disclosure of financial misdeeds by trusted executives of corporations or governments. Such misdeeds typically involve complex methods for misusing or misdirecting funds, overstating revenues, understating expenses, overstating the value of corporate assets, or underreporting the existence of liabilities. It involves an employee, account, or corporation itself and is misleading to investors and shareholders.

Dodd–Frank Wall Street Reform and Consumer Protection Act Regulatory act implemented by the Obama Administration after the 2008 Financial Crisis.

The Dodd–Frank Wall Street Reform and Consumer Protection Act is a United States federal law that was enacted on July 21, 2010. The law overhauled financial regulation in the aftermath of the financial crisis of 2007–2008, and it made changes affecting all federal financial regulatory agencies and almost every part of the nation's financial services industry.

Executive compensation in the United States

In the United States, the compensation of company executives is distinguished by the forms it takes and its dramatic rise over the past three decades and wide-ranging criticism leveled against it. In the past three decades in America executive compensation or pay has risen dramatically beyond what can be explained by changes in firm size, performance, and industry classification. It is the highest in the world in both absolute terms and relative to median salary in the US. It has been criticized not only as excessive, but also for "rewarding failure"—including massive drops in stock price, and much of the national growth in income inequality. Observers differ as to how much of the rise in and nature of this compensation is a natural result of competition for scarce business talent benefiting stockholder value, and how much is the work of manipulation and self-dealing by management unrelated to supply, demand, or reward for performance. Federal laws and Securities and Exchange Commission (SEC) regulations have been developed on compensation for top senior executives in the last few decades, including a $1 million limit on the tax deductibility of compensation not "performance-based", and a requirement to include the dollar value of compensation in a standardized form in annual public filings of the corporation.

Defender Limited is an investment fund. It was incorporated in the British Virgin Islands in 2007. Defender funneled clients' funds to Bernard Madoff's firm as part of a Ponzi scheme run by Madoff. Madoff was arrested in December 2008, and pleaded guilty to fraud in 2009. He is serving a 150-year prison term.

References

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  2. Claw Back | Definition of Claw Back by Merriam-Webster
  3. 1 2 Sepinwall, A. (2012). "Righting Others' Wrongs: A Critical Look at Clawbacks in Madoff-Type Ponzi Schemes and Other Frauds," Brooklyn Law Review, 78 (1), 1-64.
  4. "The Amazing Madoff Clawback; How two lawyers, Irving Picard and David Sheehan, have recovered 75 cents on the dollar of the stolen money—many times the usual rate in such cases," The Wall Street Journal, November 30, 2018.
  5. 1 2 3 "Madoff’s Victims Are Close to Getting Their $19 Billion Back," Bloomberg.
  6. "Second Circuit Finds Madoff Trustee can seek to Clawback Billions in Funds Transferred Abroad," Bankruptcy Litigation Briefing.
  7. "Record-Setting Madoff Settlement Announced with Picower Estate"
  8. "$7.2 Billion Picower Settlement: Payday for Madoff Victims," The Daily Beast.
  9. Glynn, Timothy P.; Arnow-Richman, Rachel S.; Sullivan, Charles A. (2019). Employment Law: Private Ordering and Its Limitations. Wolters Kluwer Law & Business via Google Books.
  10. 1 2 3 Jerin Matthew (December 20, 2013). "'Faithless' Ex-Morgan Stanley Fund Manager Ordered to Repay $31m to Former Employer". International Business Times UK.
  11. Henning, Peter J. (December 23, 2013). "The Huge Costs of Being a 'Faithless Servant'". New York Times DealBook.
  12. "Morgan Stanley seeks $10.2 million from convicted former trader". GreenwichTime. January 15, 2013.
  13. "Clawback suit seeks $420K from US transportation secretary concerning in-house counsel pay". American Bar Association.
  14. 1 2 3 Cassidy, John (November 29, 2010). "What Good Is Wall Street? Much of what investment bankers do is socially worthless".
  15. 1 2 deHaan, Ed & Hodge, Frank & Shevlin, Terry J. (2012). "Does Voluntary Adoption of a Clawback Provision Improve Financial Reporting Quality?". Contemporary Accounting Research, forthcoming. SSRN   2049442 .CS1 maint: Uses authors parameter (link)
  16. "Focus on Clawbacks". C-Suite Insight. 2011. Archived from the original on 2013-01-18. Retrieved 2012-05-16.
  17. Fried, Jesse & Shilon, Nitzan (2011). "Excess-Pay Clawbacks". Journal of Corporation Law. 36. SSRN   1798185 .CS1 maint: Uses authors parameter (link)
  18. "Listing Standards for Recovery of Erroneously Awarded Compensation" (PDF). SEC.gov. Retrieved February 10, 2018.
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