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 the executive compensation contract. [1] [2]

Contents

In law, clawback is most commonly known as restitution.

From government grantees

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
  2. annual payroll;
  3. amount of capital investment
  4. amount of depreciated value .

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. [3] [4] [5]

From employees

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 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). [6] 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. [7]

The prevalence of clawback provisions among Fortune 100 companies increased from lower than 3% prior to 2005, to 82% in 2010. [8] 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. [9]

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. [10]

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. [11] [12] [13] [14] The court called the insider trading the "ultimate abuse of a portfolio manager's position." [12] 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." [12]

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. [7] 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, [6] 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 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, some professional economists have argued that it is unlikely that either result will become the case, and that employee clawbacks are better seen as a public relations tactic until the impact of the financial crisis fades and similar abuses of the financial system can resume, with minimal or no detection by outside forces. [6]

Notable cases

In the United States, clawbacks were rarely used until 2006. [15] Major cases included a $600 million clawback affecting William W. McGuire of UnitedHealth Group, $500 million affecting Dennis Kozlowski of Tyco, and in 2019 clawbacks of compensation for the former CEO of Wells Fargo John Stumpf as well as a colleague. [15]

From investors

Clawback lawsuits in US courts, especially from innocent individuals and entities who profited from financial crimes of others, have increased in the years since 2000. [16]

The yearslong clawback undertaken after the Madoff investment scandal, which attempted to transfer money back from the financial winners to the financial losers among those who had invested in Bernie Madoff's Ponzi scheme, is notable both for the size and success of the operation. A team of lawyers headed by Irving Picard were able to recover over $13 billion, or about 75%, of the estimated $19 billion collectively lost by investors, and transfer it back to those investors who had claimed losses. [16] [17] [18] This was a far higher percentage than the usual recovery rate for investor clawbacks, which typically ranges from 5 to 30 percent. [18] Of the recovered money, $7.2 billion came from the estate of just one investor, Jeffry Picower; it was the largest civil forfeiture payment in U.S. history. [18] [19]

Other clawback types

Clawback provisions are also used in bankruptcy matters where insiders may have raided assets prior to a filing,. [20] 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.

In various countries

Italy and the Netherlands have several clawback regimes, and there are two clawback regimes in the United Kingdom. [21] The French clawback regime is limited. [21] In Belgium, their enforceability is unclear. [21]

Related Research Articles

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<span class="mw-page-title-main">Sarbanes–Oxley Act</span> 2002 U.S. law regarding corporate accounting

The Sarbanes–Oxley Act of 2002 is a United States federal law that mandates certain practices in financial record keeping and reporting for corporations. The act,, 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, SOX or Sarbox, contains eleven sections that place requirements on all U.S. public company boards of directors and 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.

Commissions are a form of variable-pay remuneration for services rendered or products sold. Commissions are a common way to motivate and reward salespeople. Commissions can also be designed to encourage specific sales behaviors. For example, commissions may be reduced when granting large discounts. Or commissions may be increased when selling certain products the organization wants to promote. Commissions are usually implemented within the framework on a sales incentive program, which can include one or multiple commission plans.

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

BakerHostetler is an American 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.

A portfolio manager (PM) is a professional responsible for making investment decisions and carrying out investment activities on behalf of vested individuals or institutions. Clients invest their money into the PM's investment policy for future growth, such as a retirement fund, endowment fund, or education fund. PMs work with a team of analysts and researchers and are responsible for establishing an investment strategy, selecting appropriate investments, and allocating each investment properly towards an investment fund or asset management vehicle.

Executive compensation is composed of both the financial compensation and other non-financial benefits received by an executive from their employing firm in return for their service. It is typically a mixture of fixed salary, variable performance-based bonuses and benefits and other perquisites all ideally configured to take into account government regulations, tax law, the desires of the organization and the executive.

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<span class="mw-page-title-main">Bernie Madoff</span> American fraudster and financier (1938–2021)

Bernard Lawrence Madoff was an American financial criminal and financier who was the admitted mastermind of the largest known Ponzi scheme in history, worth an estimated $65 billion. He was at one time chairman of the Nasdaq stock exchange. Madoff's firm had two basic units: a stock brokerage and an asset management business; the Ponzi scheme was centered in the asset management business.

<span class="mw-page-title-main">Madoff investment scandal</span> 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.

<span class="mw-page-title-main">Participants in the Madoff investment scandal</span>

Participants in the Madoff investment scandal included employees of Bernard Madoff's investment firm with specific knowledge of the Ponzi scheme, a three-person accounting firm that assembled his reports, and a network of feeder funds that invested their clients' money with Madoff while collecting significant fees. Madoff avoided most direct financial scrutiny by accepting investments only through these feeder funds, while obtaining false auditing statements for his firm. The liquidation trustee of Madoff's firm has implicated managers of the feeder funds for ignoring signs of Madoff's deception.

Recovery of funds from the Madoff investment scandal has been underway since the scandal broke in December 2008. That month, recovery trustee Irving Picard received funds from the Bank of New York account where Bernard Madoff held new investments into his Ponzi scheme. As it has been concluded that no legitimate investments were made on the investors' behalf for at least the last 12 years of operation, recovery has proceeded on a "money in/money out" basis. Investors are entitled to receive no more than the nominal cash amounts that they paid in and did not subsequently withdraw, without regard to inflation, interest, opportunity cost or the false statements that Madoff provided them. Those statements combined to a total balance of approximately $64 billion, while the admitted claims amount to $19.5 billion. As of March 2023, the trustee had recovered $14.6 billion toward these claims through legal action against Madoff associates, feeder funds and beneficiaries of the scheme, and had made fourteen distributions to investors. Action by the Department of Justice has recovered an additional $4 billion.

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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.

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Joseph F. "Chip" Skowron III is an American former hedge fund co-portfolio manager of FrontPoint Partners LLC's health care funds. He was convicted of insider trading, for which he served five years in prison. He was also required to repay his hedge fund employer $32 million it had paid him in compensation, because he had been a “faithless servant.”

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 employees who act unfaithfully towards their employers must forfeit to their employers all compensation received during the period of disloyalty.

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References

  1. ↑ "Clawback". Investopedia.
  2. ↑ Claw Back | Definition of Claw Back by Merriam-Webster
  3. ↑ "Cover". Business Facilities. Archived from the original on 2006-11-13. Retrieved 2006-09-13.
  4. ↑ "Reform". Good Jobs First. Archived from the original on 2006-08-23. Retrieved 2006-09-13.
  5. ↑ "Home page". International Economic Development Council.
  6. 1 2 3 Cassidy, John (November 29, 2010). "What Good Is Wall Street? Much of what investment bankers do is socially worthless".
  7. 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.
  8. ↑ "Focus on Clawbacks". C-Suite Insight. 2011. Archived from the original on 2013-01-18. Retrieved 2012-05-16.
  9. ↑ Fried, Jesse; Shilon, Nitzan (2011). "Excess-Pay Clawbacks". Journal of Corporation Law. 36. SSRN   1798185.
  10. ↑ "Listing Standards for Recovery of Erroneously Awarded Compensation" (PDF). SEC.gov. Retrieved February 10, 2018.
  11. ↑ Glynn, Timothy P.; Arnow-Richman, Rachel S.; Sullivan, Charles A. (2019). Employment Law: Private Ordering and Its Limitations. Wolters Kluwer Law & Business. ISBN   9781543801064 – via Google Books.
  12. 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.
  13. ↑ Henning, Peter J. (December 23, 2013). "The Huge Costs of Being a 'Faithless Servant'". New York Times DealBook.
  14. ↑ "Morgan Stanley seeks $10.2 million from convicted former trader". GreenwichTime. January 15, 2013.
  15. 1 2 Goldstein, Steve. "Only two execs have had more money clawed back than Wells Fargo's Stumpf and Tolstedt". MarketWatch. Retrieved 2020-03-15.
  16. 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.
  17. ↑ "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.
  18. 1 2 3 "Madoff's Victims Are Close to Getting Their $19 Billion Back," Bloomberg.
  19. ↑ "$7.2 Billion Picower Settlement: Payday for Madoff Victims," The Daily Beast.
  20. ↑ "Clawback suit seeks $420K from US transportation secretary concerning in-house counsel pay". American Bar Association.
  21. 1 2 3 "Clawback; A global guide" (PDF). Archived from the original (PDF) on 2019-07-21. Retrieved 2019-07-21.
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