A November 20, 2006 Wall Street Journal article entitled “Companies Discover It’s Hard to Reclaim Pay from Executives” (here, subscription required) details the difficulty that companies are having in their attempts to compel executives to return compensation they didn’t really earn because, as a result of later restatements, the company didn’t actually hit the compensation triggers. It wasn’t supposed to be like this; Section 304 of the Sarbanes Oxley Act was supposed to facilitate the possibility of reclaiming bonuses from top executives when reported income is wiped out by later financial restatements. For a host of reasons, the SOX clawback provisions in Section 304 have failed to live up to their purpose:
1. The provision is poorly written: As Stanford Law School Professor Joseph Grundfest has said (here), “For a statute that contains a lot of inartfully drafted provisions, this is among the most inartful.” The provision calls for the CFO or CEO to reimburse the company if an issuer has to prepare a restatement “due to material noncompliance of the issuer as a result of misconduct.” However, the statute doesn’t specify what constitutes “misconduct” and it doesn’t specify whose misconduct qualifies. (Must it be the CEO’s or CFO’s own misconduct? Or is a lower level employee’s misconduct sufficient?)
2. Retroactivity?: Even though the statute was enacted in 2002, restatements often reach much further back in time. For example, in connection with several of the options backdating restatements, the period of the restatement in some instances has reached back into the early nineties. The applicability of the clawback provision to compensation awarded prior to Sarbanes Oxley’s enactment raises due process and other substantive concerns.
3. No “Private Right of Action”: At least two federal district courts have held that there is no private right of action in Section 304. For example, in a derivative suit brought by shareholders of Stonepath Group to recover compensation paid to the company’s CEO and CFO, the court held, according to news reports (here), that Section 304 omitted a private right of action, by contrast to other sections of the Act where Congress made it clear whether or not investors explicitly had that right.
4. The SEC Prefers Its Other Remedies: If there is no private right of action, only the SEC can enforce Section 304. But the SEC has its own power to seek disgorgement of ill-gotten gains, which it prefers these other provisions because the other means, unlike Section 304, funnel money to shareholders rather than to the companies. The SEC has never enforced Section 304.
5. Calculating the Amount Due Can Be Tough: The Journal article linked above reports an example where a former executive of Dollar General agreed to return compensation following a restatement, but the compensation included options he had already exercised, and the shares he purchased were now valued below the price he paid. When his lawyers told him he owed $6.8 million, he said, “How on earth do you calculate that anyhow?” Attempts to recover executive compensation are fraught with these kinds of issues.
If there is no private right of action and the SEC won’t enforce the provision, Section 304 is basically worthless.
According to the Journal article, Massachusetts Democratic Rep. Barney Frank, the anticipated chairman of the House Financial Services Committee, plans to propose legislation that would strengthen the ability of shareholders to recoup executives’ compensation. Shareholder advisory services apparently are actively seeking to compel by-law changes or other measures to facilitate compensation recoveries.
Defense Fee Recoveries: The Journal also had another article (here, subscription required) on November 17, 2006 discussing the efforts of CA, Inc. (formerly known as Computer Associates) to recover $14.9 million in attorneys’ fees it paid on behalf of its now convicted former CEO Sanjay Kumar. The company obtained an order attaching Kumar’s property as security for the repayment of his attorneys’ fees.
The company’s efforts to recover attorneys’ fees are much less complicated that the attempt to try to clawback executive compensation described above. (It should be noted that CA also eventually intends to try to recover compensation paid to Kumar as well.) CA’s efforts to recover the attorneys’ fees are substantially aided by provisions in the company’s by-laws, permitted under the law of Delaware, the state of CA’s incorporation. The by-law provisions (which are set forth at length in the White Collar Crime Prof blog, here) provide that the company’s advancement of legal fees can be conditioned on the officer’s agreement to repay amounts advanced if the officer is found guilty. Kumar’s guilty plea triggers the repayment obligations.
Many companies don’t bother to try to recover advanced fees because the convicted former official has no assets. However, at least according to the Daily Caveat (here), Kumar has substantial assets, including a couple of Ferraris, a 57-foot yacht, a $9 million home, and $20 million bond portfolio (which he just happened to transfer to his wife’s name the day after the New York Times ran an article questioning his company’s accounting). On the other hand, there are a lot of potential claimants for Kumar’s assets (including the SEC, seeking to pursue its own recoupment action) that could have a superior claim on Kumar’s assets.