Thread Title: Third Turn Fraud
Created On Tuesday October 09, 2012 10:30 PM
  Third Turn Fraud


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Tuesday October 09, 2012 10:30 PM

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I wonder if anyone else is recognizing that there is a new type of fraud, mostly a payroll scheme, that began in the 1990s and continues to grow. Since it is peaking in association with the turn of the third millenium I decided to label it the 'third turn fraud.' If this fraud has already been identified and labeled by someone, then forget this name for it.

The third turn fraud in its simplest form is perpetrated by a management team that sets up a self-controlled performance evaluation system for awarding themselves a substantial performance payout. Inherent to all forms of this scheme is absence of the owners or ownership class, which would otherwise be the key control for limiting compensation. Instead, the owners have an indirect relationship with the management team, usually through middle men and organizations that are expected to exercise fiduciary duty to limit compensation to the executives and management. The management team seduces the fiduciaries by spreading the scheme widely - all employees get a share of the loot, with the lower-ranking employees getting such a small share that it is a reasonable performance bonus at the lowest levels. The scheme has the look and feel of an incentivized performance pay system, but the management team always gets an outsized payout. If things are so bad that the metrics cannot be fudged, then performance is blamed on the economy and again the management team gets a big payout even if the company has to borrow money to afford it.

In more complicated applications the third turn fraud is perpetrated by a venture capital firm, preying on a company that needs capital. Management of the target firm is brought into the fold through large bonuses and golden parachutes and in return they give their approval and endorsement for the company to take on a toxic load of debt. The venture capital firm is richly compensated by the target company as a hefty share of the toxic debt load is really just kicked straight back to the venture capital firm that sets this up. The target company goes bankrupt, leaving the absent owners (pensioners and 401K participants) holding the empty bag. The brokerage firms that were supposed to perform as fiduciaries were also earning sufficient fees associated with the leveraged buy-out transaction and hide behind a veneer of negligence. Groups of brokerage firms may trade these leveraged buy-out fee 'opportunities' between themselves to create the illusion of objectivity.

A key element of this fraud, in addition to absence of the ownership class, is embarassment of those who would call it out. The implication is that you are jealous, acting 'tacky' to question the scheme's outsized payouts. The perpetrators will exploit any tiny crack in the personal self-esteem of the accuser, isolating and branding the accuser as an outcast, a mis-fit that cannot adapt.

The simplest and quickest way to address this fraud is to call it out, drag all of its pieces out into the light, prepare alternate metrics that paint a more complete and honest picture of performance. Another way to address this fraud is to confront the management team with clear metrics about turnover at the top and demonstrate that the risk of losing executive talent to higher-paying competitors is mere speculation, an over-hyped risk.

Others want to throw in here, help define this monster?

Edited: Tuesday October 16, 2012 at 9:52 PM by weeeehatter


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