The SEC vs. CEO Pay

The SEC vs. CEO Pay. By RUSSELL G. RYAN
The agency stretches the law to confiscate a bonus.
WSJ, Aug 05, 2009

A lawsuit filed on July 22 by the Securities and Exchange Commission (SEC) should send a mid-summer chill down the spine of every chief executive and chief financial officer of a U.S. public company.

Exploiting an ambiguously worded phrase in Sarbanes-Oxley, the agency has for the first time claimed that it may under that law “claw back”—some might say confiscate—bonus money and stock sale proceeds from CEOs and CFOs even when it lacks evidence to charge them with wrongdoing.

Sarbanes-Oxley was rushed through Congress in the summer of 2002 in reaction to public outrage over notorious corporate accounting failures at Enron, WorldCom and other companies. As is often the case with such far-reaching and hastily conceived legislation, many of its details were half-baked, poorly worded, and riddled with ambiguity.

A prime example was the so-called clawback feature of Section 304, which was designed to prevent crooked CEOs and CFOs from taking home big bonuses and cashing out company stock while they were knowingly defrauding shareholders. It empowered the SEC to force these executives to reimburse their companies for all bonuses and stock sale proceeds received during any financial period for which their company was later required to restate its financial statements due to “misconduct.”

But in its haste to “do something” about the scandal of the day, Congress muddied the question of whether the “misconduct” required for such a clawback had to be committed by the executive himself (or at least known to him), or could be that of a subordinate, completely unbeknownst to the executive.

Many executives and legal advisers have cautiously assumed that bonuses and stock proceeds were at risk only for executives who actually engaged in misconduct themselves—or at least were aware of it and acquiesced. In fact, the SEC itself has rarely used this feature of Sarbanes-Oxley at all, and had done so only in cases where it alleged personal misconduct by the targeted chief executives or chief financial officers. A prominent example was the agency’s stock-option backdating case against Dr. William McGuire, the former CEO of UnitedHealth Group.

But the SEC has abruptly changed course. It has sued Maynard Jenkins, the former CEO of CSK Auto Corporation, an auto-parts company that had previously settled with the agency on charges of accounting fraud after restating three years’ worth of financial statements.
Several subordinate executives have been charged with both civil and criminal securities law violations. But the SEC has never accused Mr. Jenkins of any wrongdoing. In a press release announcing this case, the agency highlighted its novel position that no such accusation—much less proof—was necessary to claw back his bonuses and stock sale proceeds for the three years in question, which totaled more than $4 million.

Mr. Jenkins is contesting the lawsuit, and he has grounds for optimism. On a visceral level, it seems shocking that a U.S. law enforcement agency could take more than $4 million from any citizen without so much as an accusation of personal misconduct, or at least knowing acquiescence in someone else’s misconduct. Indeed, according to a report by Bloomberg, two of the SEC’s five commissioners voted not to file the lawsuit at all.

In an unrelated case earlier this year, the SEC unsuccessfully argued an equally aggressive interpretation of Section 304. Stretching the law’s wording that clawbacks are appropriate only when a company is “required to prepare an accounting restatement,” the agency argued that Section 304 also allows clawbacks when no restatement is actually prepared, so long as the SEC later concluded the company should have done so.

A federal judge in St. Louis rejected that theory and threw out the charge. In recent years, courts have similarly rejected the agency’s overly aggressive interpretations of laws preventing “selective disclosure,” insider trading, aiding and abetting, and other violations.

The irony is this. Despite all the recent criticism the SEC has taken for supposed laxity in its enforcement program, the agency has in fact consistently taken very aggressive positions in its enforcement cases, such as with laws concerning foreign bribery, market timing of mutual funds, and many forms of insider trading.

For the most part, investors expect the SEC to push the envelope to protect their interests. But the wisdom and fairness of pursuing no-fault clawbacks from unaccused executives is dubious at best.

Mr. Ryan is a securities lawyer and was an assistant director of the Securities and Exchange Commission’s division of enforcement from 2000-2004.