It seems it should be a fairly intuitive policy: employees who violate the law should not be entitled to keep big bonuses earned based on illegal behavior.
Until recent years, recovering that money wasn’t a given on Wall Street. Firms are starting to insert provisions in employment contracts, however, allowing them to claw back compensation from employees who violate the law.
The latest such move was announced last week by the hedge fund SAC Capital Advisors and its owner, Steven A. Cohen. The firm, which is the focus of an insider trading investigation, said it would use such measures to bolster its compliance practices.
A clawback is a means to recover money paid to an employee while the employee was engaging in wrongdoing that came to light later. It reflects the notion that a thief should not be allowed to enjoy the fruits of the crime, even if no one notices the violation until later.
A clawback is a fairly simple mechanism that gives an employer the contractual right to recover compensation paid in salary, bonus and deferred stock grants if certain conditions are met. One trigger can be that employees engaged in wrongdoing that helped to inflate their pay.
Clawbacks have become much more common in recent years as companies have sought to recover at least some of the costs of government investigations that can result in millions of dollars in expenses for legal fees and settlements. They have also been used in seeking recoveries from the “net winners†who invested in the Ponzi scheme perpetrated by Bernard L. Madoff.
In cases where insider trading is involved, putting in place clawback provisions at hedge funds is a logical step because of the risk that misuse of inside information can quickly cause a firm’s demise when charges are filed. Some hedge funds tainted by insider trading have shut down in the face of investor withdrawals, even if only a small part of the firm is involved.
Congress has embraced clawbacks as a means to redress corporate misconduct. The Dodd-Frank Act has a provision called “Recovery of Erroneously Awarded Compensation.†The rule requires publicly traded companies to adopt policies under which executive officers must return up to three years of incentive-based compensation if there is an accounting restatement. The Sarbanes-Oxley Act, adopted after the financial chicanery at Enron and WorldCom, has a similar provision limited to just the chief executive and chief accounting officer at a company.
JPMorgan Chase used its mandated clawback provision to recover compensation from traders involved in the so-called London whale transactions, which have cost the bank over $6 billion in losses.
Even without a clawback provision in place, some firms have refused to pay deferred compensation to former officials convicted of insider trading, and even sought to reclaim compensation paid years earlier.
One means to seek to recover compensation has been to use the process of sentencing defendants through the Mandatory Victims Restitution Act. Under that statute, a victim of a crime can seek to recover any “property†lost in the crime.
Compensation would not appear to qualify when a firm benefited from the insider trading by one of its employees. Some courts, however, have taken an expansive view of what can be recovered from an employee who trades on confidential information.
For example, in the sentencing of Joseph F. Skowron III, for insider trading, a court ordered him to return $6.4 million to Morgan Stanley, his former employer, representing 20 percent of his compensation from 2007 to 2010. He appealed the restitution order to the United States Court of Appeals for the Second Circuit in Manhattan in January, and a decision should be announced soon.
Others have gone so far as to revoke deferred compensation owed to a defendant convicted of insider trading without resorting to the courts, essentially daring the former employee to sue to recover any amounts owed.
Goldman Sachs terminated restricted stock units and options worth approximately $1 million owed to Rajat Gupta from his service on the bank’s board. He was convicted for tipping Raj Rajaratnam about corporate developments at Goldman, a case that caused the firm substantial embarrassment.
Level Global, a shuttered hedge fund firm, has not paid more than $37 million in deferred compensation to Anthony Chiasson, one of its founders, after his conviction for insider trading. In a memorandum filed with the district court ahead of his sentencing next week, Mr. Chiasson asserts that the firm “improperly converted†his compensation without legal authorization.
While clawbacks are required for large public companies, these provisions are limited to executive officers and usually are put into effect because of accounting restatements, something that has little relevance for insider trading cases.
By instituting an express clawback provision, SAC is part of a trend on Wall Street to make this part of employment agreements.
Unlike the self-help approach taken by Goldman and Level Global, a clear policy on clawing back compensation can put a firm on stronger legal ground to revoke deferred compensation awaiting distribution. Some could even go a step further by including a right to recover salary and bonuses previously paid if the employee is found guilty of a crime.
While SAC promoted its clawback as part of an approach of “zero tolerance for wrongdoing,†whether this type of policy will have any deterrent effect on insider trading is another issue. DealBook noted the skepticism of a former federal prosecutor now in private practice who asked, “Do they need an inducement to not violate the law?â€
The answer, of course, is that the wealth to be gained from trading on confidential information is so powerful that the potential threat of losing a few years’ worth of deferred compensation is unlikely to be enough to stop someone from violating the law. The string of insider trading cases pursued by the Justice Department over the last four years shows just how much pressure there is on hedge funds to produce results, with inside information serving as the currency for many successful trades.
A clawback is more of a salve to make a firm feel a little bit better when misconduct is discovered in its ranks. Even if insider trading cannot be stopped, at least the policy might help keep some money away from a miscreant employee while showing that a firm is taking a small measure to ensure compliance with the law.
US v Chiasson Sentencing Memorandum on Behalf of Chiasson
