SEC Claws Back Again

Editor’s Note: Wayne Carlin is a partner in the Litigation Department at Wachtell, Lipton, Rosen & Katz. This post is based on a Wachtell Lipton firm memorandum by Mr. Carlin and John F. Savarese.

The SEC recently announced a settled enforcement action in which it obtained a “clawback” of prior compensation and stock sale profits from a CEO pursuant to Sarbanes-Oxley Section 304.  SEC v. McCarthy, No. 1:11-CV-667-CAP (N.D. Ga. March 3, 2011).  This case marks the second time the SEC has obtained this type of relief without alleging that the CEO in question personally engaged in any wrongdoing.  See our prior memos concerning Section 304 clawbacks dated June 16, 2010 [“Sarbanes-Oxley Clawback Developments”] and July 24, 2009 [“SEC Pursues Unprecedented Sarbanes-Oxley Clawback”].

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 SEC’s position is that the issuer’s “misconduct” alone is a sufficient predicate for this relief, and that it need not establish any personal misconduct by the CEO or CFO.  The SEC’s position is supported by the one federal district court decision that has been rendered on this issue.  SEC v. Jenkins, 718 F. Supp. 2d 1070 (D. Ariz. 2010).

The defendant in SEC v. McCarthy is the CEO of Beazer Homes USA, Inc.  Beazer had previously restated its financial statements and entered into a settled cease-and-desist proceeding with the SEC, as well as a deferred prosecution agreement with the Department of Justice.  The SEC also previously charged the company’s former chief accounting officer with violations of the antifraud provisions of the federal securities laws, but the CEO was never charged with any misconduct in any of these proceedings.

Under the Section 304 settlement, the CEO agreed to reimburse to the company $6,479,281 (comprised of bonus payments plus certain stock sale proceeds); 40,103 restricted stock units; and 78,763 shares of restricted stock.  Although the SEC has been silent concerning its general approach to calculating the amounts recoverable under Section 304, this settlement may reflect a recognition that not all proceeds from the sale of stock are appropriately reimbursable.  The SEC’s complaint alleges $7.3 million in stock sale profits during the relevant period, yet the portion of the settlement attributed to stock sale proceeds is $772,232.

Finally, the SEC has never publicly articulated the criteria it applies in determining whether or not to pursue such no-fault Section 304 relief.  Greater transparency about the Commission’s criteria would be in the public interest.  Now that the SEC has had some initial success in establishing that it can recover substantial sums from individuals who are not accused of any wrongdoing, it would be appropriate for the SEC to provide some explanation concerning when it will seek this extraordinary form of relief.

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