Kevin LaCroix reports on the SEC's latest use of Sarbanes-Oxley Section 304 to clawback compensation from a CEO who was not charged with personal wrongdoing in connection with securities fraud issues at his company:
... the SEC reached a settlement with the former CFO of Beazer Homes to return more than $1.4 million in bonus compensation he earned during a period when the company was committing accounting fraud. As is contemplated under Section 304, the former CFO, James O’Leary, was obligated to return the bonus compensation even though he was himself not charged with any wrongdoing in connection with the accounting fraud. The SEC’s August 30, 2011 press release about the settlement can be found here. ...
These SOX Section 304 clawback actions against Beazer Homes CEO and CFO follow prior Section 304 clawback actions in which the SEC has sought reimbursement of compensation paid to corporate officials they had earned during periods in which their companies had made financial misstatements, as I discussed in an earlier post. As was the case in the actions against Beazer’s CFO and CEO, in the prior actions the officials involved were not alleged to have been involved in or aware of the financial misreporting. At least one court (refer here) has affirmed the SEC’s authority to pursue the compensation clawback under these circumstances, under SOX Section 304.
LaCroix seems uncertain of section 304's merits:
Though statutorily authorized, the implementation of a forfeiture without culpability or fault raises troubling questions, including even basic questions of fairness. On the other hand, it might also fairly be asked whether the CEO or CFO ought to be able to retain benefits accumulated at a time when the investing public was being misled, by financial statements that the CEO and CFO certified, about the company’s financial condition. As an SEC official was quoted as saying in the press release about the SEC’s settlement with O’Leary, “Section 304 of the Sarbanes-Oxley Act encourages senior management to take affirmative steps to prevent fraudulent accounting schemes from occurring on their watch.”
I'm likewise of two minds on this issue. On the one hand, as I've argued here before: During the 1990s, restating financials became commonplace. Some firms were notorious for taking incredibly aggressive accounting positions. When they were called out for it, they simply restated their financials and claimed the SEC and/or private claim was moot.
As illustrated by other provisions of SOX, such as the CEO and CFO certification rules, Congress concluded that too many CEOs and CFOs had simply turned a blind eye to misconduct by subordinates. A claw-back rule that essentially imposes strict liability on CEOs and CFOs for subordinate misconduct arguably provides a powerful incentive for CEOs and CFOs to ensure that the company's internal controls work.
A related argument is that much corporate financial statement shenanigans during the 1990s appears to have been motivated by efforts to maximize the value of top manager's stock options and other forms of equity and incentive compensation. Or, at least, so Congress concluded. It's precisely those forms of compensation that section 304 targets. The CEO and CFO, one might argue, should not be allowed to benefit from misconduct by subordinates, whether or not the CEO or CFO was aware of the misconduct. Any other rule would perpetuate the incentive to turn a blind eye.
On the other hand, I am troubled by the fairness issues LaCroix notes. I'm also concerned that a strict liability approach to section 304 would tend to encourage CEOs and CFOs to resist restating flawed financial statements and/or to game the timing of their compensation and stock transactions relative to any such restatements.
We also now know that section 304 prompted companies to increase "non-forfeitable, fixed-salary compensation and decreased incentive compensation, thereby providing insurance to managers for increased risk." Sanjai Bhagat & Roberta Romano, Reforming Executive Compensation: Focusing and Committing to the Long-Term, 26 Yale J. Reg. 359, 366 (2009).
The merits of section 304's strict liability approach thus remain highly debatable.
