In the latest example of the SEC’s use of its compensation clawback authority under Section 304 of the Sarbanes-Oxley Act, 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.
The SEC has previously accused Beazer Homes and its former chief accounting officer, Michael Rand of accounting fraud. In September 2008, Beazer settled its SEC enforcement action. The SEC action against Rand is continuing. Last year, as reported here, Rand was separately indicted on charges including securities fraud and witness tampering. The SEC alleges that during various fiscal years including 2006 Rand and other employees misreported the company’s income by releasing redundant reserves to avoid missing analysts’ estimates.
O’Leary served as CFO from 2003 to 2007. However, in the SEC complaint against him, he was not charged with any involvement with or even any awareness of the accounting improprieties. Under Section 304, if any reporting company fails to comply with the financial reporting requirements of the federal securities laws, then the company’s CEO and CFO can be compelled to return bonus compensation or stock sale profits earned during the twelve months following the financial misreporting. Section 304 does not require that the CEO or CFO be personally charged with the misconduct or to have otherwise violated the securities laws.
Under the terms of his settlement with the SEC, which is subject to court approval, O’Leary agreed to reimburse Beazer more than $1.4 million in case, including his fiscal 2006 bonus of $1.02 million, plus $131,733 in stock compensation. He also agreed to reimburse the company $274,525 in stock sale profits.
O’Leary’s settlement follow the SEC’s similar March 2011 settlement with Beazer’s CEO Ian McCarthy, who returned several millions of dollars in bonus compensation and stock compensation he had received.
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.
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.”
Regardless of where you come down on the propriety of the compensation clawback without culpability of any kind, the question is about to extend a much broader array of corporate officials. As discussed here and here, under Section 954 of the Dodd-Frank Act, the national securities exchanges are required to promulgate rules requiring reporting companies to adopt and disclose procedures providing for the recovery of any amount of incentive based compensation paid to any current or former executive that exceeds the amount which would have been paid under an accounting restatement in the three years prior to the date on which the company was required to prepare the restatement. The Dodd-Frank provision is quite a bit broader than Sox Section 304, as it extends to all executives and it reaches back three years and to all incentive based compensation.
As I have previously noted (here), these provisions allowing for the return of compensation without fault or culpability raise a host of potentially troublesome insurance coverage issues. The marketplace has responded, as many carriers are now willing in at least some cases to add a provision to their policy stating that the policy will cover defense expenses incurred in connection with a SOX 304 action.
With the advent of the Dodd-Frank Section 954 requirements, it may be worth asking whether the relatively new Section 304 policy provisions need to be further extended to clarify that the policies will also provide coverage for defense expenses incurred in a Section 954 action or any other compensation clawback provision.
Beazer Homes financial misreporting has led to a slew of litigation. As discussed here, Beazer previously settled for $30.5 million the subprime-related securities class action lawsuit that had been filed against the company and certain of its directors and officers. And as discussed here, the company also settled the separate subprime-related shareholders’ derivative suit that had been filed against the company, as nominal defendant, and certain company officials.