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]

Financial crime clawbacks[edit]

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]

Faithless servant clawback[edit]

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]

Clawback provision[edit]

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.

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]

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[edit]

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[edit]

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[edit]

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[edit]

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]

References[edit]

  1. ^ "Clawback". Investopedia.
  2. ^ Claw Back | Definition of Claw Back by Merriam-Webster
  3. ^ a b 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. ^ a b c "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. ^ a b c 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. ^ a b c Cassidy, John (November 29, 2010). "What Good Is Wall Street? Much of what investment bankers do is socially worthless".
  15. ^ a b 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.
  19. ^ "Cover". Business Facilities. Archived from the original on 2006-11-13. Retrieved 2006-09-13.
  20. ^ a b "Reform". Good Jobs First. Archived from the original on 2006-08-23. Retrieved 2006-09-13.
  21. ^ "Homem page". International Economic Development Council.
  22. ^ a b c Clawback; A global guide