Sarbanes-Oxley ”Clawback” Developments

John Savarese is a partner in the Litigation Department of Wachtell, Lipton, Rosen & Katz. This post is based on a Wachtell Lipton firm memorandum by Mr. Savarese and Wayne M. Carlin, and relates to the decision in the recent case of SEC v. Jenkins, which is available here.

The SEC recently achieved a significant victory in its campaign to use the “clawback” provision under Sarbanes-Oxley to force the return of incentive-based compensation by CEOs and CFOs to issuers, even when they are not personally responsible for any alleged “misconduct.” SEC v. Jenkins, No. CV 09-1510-PHX-GMS (D. Ariz. June 9, 2010). The court in Jenkins denied a motion to dismiss the SEC’s complaint seeking an order directing Maynard L. Jenkins, the former CEO of CSK Auto Corporation, to pay back to CSK over $4 million in bonuses and stock sale proceeds that Jenkins received during a period for which CSK’s financial statements were later restated. The case is noteworthy because the SEC has pointedly not charged Jenkins with any wrongdoing, notwithstanding that other former CSK executives have faced both civil and criminal accounting fraud charges. (See our memo, SEC Pursues Unprecedented Sarbanes-Oxley “Clawback,” July 24, 2009.)

Sarbanes-Oxley Act Section 304 requires a CEO or CFO to return incentive-based compensation to an issuer when a financial restatement occurs “as a result of misconduct . . . .” The Jenkins court rejected the argument that this obligation can arise only where the “misconduct” has been committed by the CEO or CFO in question. Rather, the court held that the triggering event is misconduct by the issuer, acting through any of its officers, agents or employees.

As this was a motion to dismiss, the court did not address the ultimate merits of the SEC’s particular claim against Jenkins. Nor did the court’s opinion answer some important open questions concerning the scope of this extraordinary remedy. Jenkins had argued that the SEC was obligated to specify the portion of his incentive-based compensation during the relevant period that the SEC would contend was traceable to the misstatement of CSK’s financial results. The court did not reject the concept that some portion of the bonuses and stock sale proceeds received by Jenkins during the relevant period may not have been fairly attributable to CSK’s misstatements. Instead, the court found that this issue requires development of a factual record, and cannot be determined on a motion to dismiss. Similarly, the court did not reject the possibility that the amount or method of calculating the proposed recovery could be so excessive as to raise constitutional issues – again, that issue must await factual development.

While the Jenkins decision is not binding on any other court, this result in the first litigated no-fault clawback case will certainly reinforce the SEC’s view that this remedy can be deployed in appropriate cases, even in the absence of allegations of personal misconduct by a CEO or CFO. The SEC and its Staff have shown a willingness to pursue no-fault clawbacks in other cases, such as the recent $470,016 settlement by the former CEO of Diebold, Inc. SEC v. O’Dell, No. 1:10-cv-00909 (D.D.C. June 2, 2010). The issues left open by Jenkins signal that there is still room for vigorous advocacy – whether before the SEC or in court – over the proper scope and calculation of a clawback recovery.

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One Comment

  1. alex
    Posted Wednesday, July 14, 2010 at 6:18 am | Permalink

    Provision looks good, but seriously departs from separate entities concept. It looks like CEO and CFO are personally liable for anything, that happens in the company.