Creditors Could Go After Lehman Bonuses

Whether employees get to keep their generous $5.7 billion in 2007 bonuses may depend on whether the bank is found to have been solvent at the time they were made.

Schaeffer says that “99 out of 100 times [bonuses] won’t be called a preference claim,” but rather a fraudulent conveyance. However, the trustee could go either way.” He adds that creditors and trustees often sue under fraudulent conveyance because there is no formalized defense for the claim, as is the case with preference payments. For example, if there is evidence that a preference payment was made in advance, cash on delivery, in the usual course of business, or is backed by surety bonds, the preference claim may automatically be denied, explains Schaeffer.

The key for creditors in the Lehman case will be to prove that the bonuses were not paid out in the ordinary course of business, says Williams. “That point will be debatable,” says Williams, who reckons creditors will have to prove that paying out bonuses to managers who ran the company into bankruptcy was considered business as usual.

If creditors do not find any wrongdoing among Lehman employees, they will be hard-pressed to recoup any bonuses, says Richard Smith, a senior vice president of the compensation advisory firm Sibson Consulting. “Even though the company is down, according to the structure they had, they earned those bonuses,” says Smith, referring to the majority of Lehman employees. “They may try to go for the senior executives and look at their contracts.”

Lehman’s bonuses — like the bonus pay at other banks — were based on short-term incentives, says Seth Jayson, a senior analyst at Motley Fool, an independent research firm and investor website. But the short-term view “doesn’t work out well in the long term,” he adds.

Derivatives and other complex instruments that banks count as part of their earnings are opaque and hard to value, making reported earnings in essence an “opinion” based on in-house models. “It was a grand shared delusion [among banks, investors, and politicians] that this stuff was worth more because someone was willing to pay more for it,” says Jayson.

And while the valuations usually are made in good faith, they may be incorrect, and “can become fiction quickly.” In defense of fair-value accounting, Jayson adds, “Everyone likes to blame measurement schemes, when all it does is reveal the actual situation.”

Creditors and shareholders have sought to recoup bonuses in the past with varying levels of success. In 2003, former Enron employees had little luck when they sued the energy company’s executives for $73 million in bonuses they had received. In the 1990s, however, regulators sued former employees of Drexel Burnham Lambert, an investment bank that declared bankruptcy in the wake of collapse, for $250 million of bonuses that many agreed to repay. Lehman’s Fuld may have less to hold onto, as he announced in July that he would forgo his 2008 bonus due to the bank’s poor performance.

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