The pervasiveness of clawback provisions among Fortune 100 companies increased from under 18 percent in 2006 to over 82 percent in 2010. "Focus on Research: Clawbacks Are Here to Stay," C-Suite Insight, Jan. 2011, at 40, 40–41. The growing trend of clawback claims is likely due in large part 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 SEC has enforced its clawback powers in only a small number of cases. Jesse M. Fried & Nitzan Shilon, "Excess-Pay Clawbacks," 36 J. Corp. L. 721, 731–32 (2011).
Beginning in 1999, Arthur Nadel managed six hedge funds through the two investment management companies he controlled. Nadel was actually running a Ponzi scheme, as all of the hedge funds were dramatically undercapitalized. Although the funds claimed to have assets in the hundreds of millions, the actual valuation of the funds was a mere $500,000. When Nadel's scheme collapsed, investors lost millions and scrambled to recover any assets in the possession of Nadel's holdings.
The SEC also became involved in efforts to recover or "claw back" alleged false profits earned by early investors in Nadel's scheme. One such clawback claim is the substance of the case of Wiand v. Schneiderman.
Facts of the Case
In 2003, Herbert Schneiderman became a limited partner in Victory Fund, Ltd., a hedge fund operated by Arthur Nadel. Victory Fund issued subscription documents and a limited partnership agreement. Both documents contained an arbitration provision. Shortly after executing the subscription documents and limited partnership agreement, Schneiderman was treated as a limited partner of Victory Fund. Consequently, his initial investment of $100,000 was credited to his capital account as were all subsequent gains and losses. These "gains and losses" were reported to limited partners in quarterly statements reflecting the balances of each partner's account.
Schneiderman died in October 2007. At the time of his death, the valuation of Schneiderman's interest in Victory Funds as stated in his capital account was $263,660.48. That amount was distributed to his estate.
In January 2009, the SEC brought an emergency enforcement action against Nadel, his investment management companies, and the six hedge funds connected with his scheme, charging them with multiple counts of violating the federal securities law. The SEC sought the appointment of a receiver to manage and preserve all assets of the hedge funds. The court appointed Burton Wiand as the receiver.
Wiand filed over 150 clawback claims in an effort to recover alleged "false profits" earned by early investors in Nadel's Ponzi scheme. With respect to the Schneiderman estate, Wiand filed suit contending that only $100,000 of the distributive interest paid to Schneiderman's estate was bona fide and that the remaining balance of $163,660.48 constituted "false profits" that were subject to the clawback claim.
The Schneiderman estate moved to compel arbitration based on the subscription agreement and limited partnership agreement between Schneiderman and Victory Fund. The arbitration clause was broad and provided for arbitration of any disputes or controversies that arose from the agreements. Ultimately, the district court compelled arbitration. Subsequently, the arbitrator ruled in favor of the Schneiderman estate by granting the estate's motion for summary decision.
On appeal, Wiand made four arguments as to why the district court erred in compelling arbitration. The one discussed here is his contention that the receivership statutes creating his position preclude the use of arbitration in clawback actions.
The Eleventh Circuit's Ruling
The FAA, 9 U.S.C. §§ 1 et seq., mandates that arbitration agreements be enforced unless "overridden by a contrary congressional command." Shearson/Am. Express Inc. v. McMahon, 482 U.S. 220, 226–27 (1987). Accordingly, a party seeking to avoid arbitration bears the burden of establishing Congress's intent to prohibit waiver of a judicial forum in favor of arbitration for claims involving receivership or securities law. The objecting party can demonstrate a contrary congressional command using a statute's text or legislative history, or by identifying an "inherent conflict" between arbitration and the statute's underlying purposes. McMahon, 482 U.S. at 226–27.
Wiand argued that there was an inherent conflict between arbitration and the underlying purpose of 28 U.S.C. § 754, the statute governing receiver appointment. In support of this argument, Wiand relied on prior cases where courts have found inherent conflicts between arbitration and other statutory schemes designed to streamline the distribution of assets. For example, when considering the use of arbitration in a bankruptcy case, the Fourth Circuit concluded that Congress intended to centralize disputes about a debtor's assets and legal obligations in the bankruptcy courts, and that "[a]rbitration is inconsistent with centralized decision-making." In re White Mountain Mining Co., 403 F.3d 164, 169 (4th Cir. 2005). In short, Wiand contended that clawback claims, like bankruptcy cases, are designed to facilitate the equitable distribution of assets. Consequently, clawback actions also inherently conflict with the enforcement of arbitration clauses.
The Eleventh Circuit held that the language in 28 U.S.C. § 754 that conveys "complete jurisdiction and control" over receivership assets flows to the receiver and not the district court. Therefore, the jurisdiction mentioned in the statute does not refer to the district court's authority to decide all disputes relating to the contested property, but rather to the receiver's right to take charge of all contested property regardless of its physical location.
Having determined that 28 U.S.C. § 754 does not grant exclusive jurisdiction of clawback suits to the appointing district court, the court next focused on Wiand's comparison of clawback claims to bankruptcy proceedings. The court held that the body of case law related to bankruptcy matters was distinguishable from receivership actions because where a statute provides a special method for the resolution of a particular type of dispute (i.e., bankruptcy), resolving that type of dispute in any other manner would inherently be contrary to the statute. However, the statute authorizing receiverships simply provides authority for a particular person or entity to manage the collection and distribution of receivership assets; 28 U.S.C. § 754 does not establish an explicit method for distributing those assets. The court went on to compare the role of a receiver to that of a trustee in a bankruptcy proceeding.
The court further noted that a receiver stands in the shoes of the receivership entities and not the creditors. Therefore, the receiver is bound by the arbitration clause to the same extent that the receivership entity is bound. Because the receiver stood in the shoes of Victory Fund, he was required to submit to the arbitration agreement negotiated between Victory Fund and Schneiderman.
Finally, the court considered that other courts have referred similar disputes under securities laws to arbitration. The prior precedent related to similar cases, when coupled with the "liberal federal policy" in favor of arbitration, moved the court to hold that there was no inherent conflict between arbitration and the underlying purpose of court-appointed receivers pursuing clawback claims. As such, the receiver failed to meet his burden to prove that arbitration of clawback claims was overridden by contrary congressional intent justifying divergence from the FAA.
Significance for Future Clawback Claims
In short, the Eleventh Circuit solidified its intent to enforce arbitration agreements absent a clear conflict between arbitration under the FAA and the purposes of a governing statute. Absent congressional amendment to 28 U.S.C. § 754, the ruling in Wiand v. Schneiderman will make it virtually impossible for receivers in clawback claims to avoid arbitration.
Keywords: litigation, ADR, arbitration, clawback clause, receivership, 28 U.S.C. § 754, Arthur Nadel, FAA