Claw Back

Recently I’ve added Ponzi Tracker to my RSS reader and it’s fun in that way that we all enjoy things that feed our confirmation bias.  And who doesn’t love a story about a criminal.  Today’s post included this bit:

“… the court-appointed Receiver, Kenneth D. Bell, begins his quest to recover “false profits” from thousands of victims that were fortunate enough to profit from their investment.  The receiver’s efforts to recover these “false profits” will become markedly easier in the event that Burks pleads guilty to the fraud, since the guilty plea or conviction of a Ponzi schemer allow the use of the “Ponzi presumption” that significantly simplifies the burden of proof required in the so-called “clawback” actions.”

I didn’t know that.  It seems like a big gaping hole in the investor protections that encourage corporate risk taking.  The reason we have limits on investor liability is that it lets the investors delegate risk taking to the corporation while avoiding the worst case scenarios that they will be held responsible for the evil that firm does.  Their risk is limited to the amount of their investment.  Back in the day only the king had the power to get away with murder, but then it devolved to his friends.

So I’d love to know why Ponzi schemes are unique in this regard.  And I’d love to know that if we convicted a few large financial firms of just the right crimes we could then claw back the money from the “lucky” ones who cashed out early.

Any amateur social scientist knows the next question: What about incentives?  If you threaten investor class it creates an incentive.  Presumably the kings friends let this loophole appear because the victims of Ponzi schemes are somehow unique when compare to the other victims of corporate malfeasance.  Maybe it’s about affinity.  Which is ironic, as affinity is a common feature of Ponzi schemes, but in this case I think it might be that the Ponzi victims are called “investors.”

If only the victims of the mortgage crisis had called themselves investors.  If only we could learn use that phrase “false profits” more.

1 thought on “Claw Back

  1. Douglas Knight

    First of all, in ordinary commerce, stolen goods are seized. I believe that the same is true of cash from the sale of stolen goods. That is, if someone purchases stolen goods, subsequently seized by police, he may sue the seller for the purchase price, even if the seller did not know of the crime.

    Second, this is hardly the only kind of profit from a limited liability corporation that can be clawed back. If the LLC takes out a loan to pay dividends right before going bankrupt, that is also a false profit. That is so obvious, it never happens. More common is that it discriminates between creditors in the months of insolvency leading up to bankruptcy, but this does not involve investors.

    What is special about Ponzi schemes is that all of the profit was stolen. Most corporate crimes are a small part of the corporation’s value and so they can pay restitution without clawing back dividends. More common is trying to claw money back from the CEO. Also what is special is the long time frame. Another example with a long time frame is environmental crimes. When these are discovered long after the fact, the company having dissolved, very little attempt is made to claw back profits to pay for the damage. I think an important difference is that Ponzi schemes end with a bang, not a whimper. They are immediately visible and of course money will be clawed back from the most recent recipients. People don’t want to draw a line and say that recent withdrawals are liable and old ones are not. Whereas, they are willing to draw a line between old well-hidden environmental crimes and ones caught on-going. (Not that that’s a good incentive.)

    As for the subprime crisis, Countrywide did not have enough value left in it to pay for the lawsuits against it, but first it was bought by Bank of America, which did. Could Bank of America sue Countryside’s prior stockholders for the past few years of dividends? Or if they hadn’t bought it, could the people suing it have done so? I doubt it, for it was all a civil matter, never criminal.

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