SOX's clueless clawbacks

The WSJ discusses clawbacks of executive compensation that was calculated on the basis of misstated accounting results. Sounds like a simple concept, doesn't it? Sure did to Congress when it decided to wade into this basically state law issue of executive pay in Section 304 of SOX. But even this little aspect of SOX is causing big problems.

The problem is, that as I have said, Market v. Regulatory Responses to Corporate Fraud, 28 J. Corp. L. 1, 35 (2002) (online):

Section 304 includes a kind of vicarious liability provision by requiring executives to return compensation or stock profits following a misconduct-induced accounting restatement. Notably, although the provision requires a showing of "misconduct," it does not require that the reimbursing executive have participated in the misconduct, or that the amounts reimbursed relate to the accounting misstatement. Although damages are limited to stock profits or compensation, this does not negate the penalty aspect of the reimbursement.

The WSJ article discusses an attempt by FPL Group to recover bonuses paid for a busted merger, starting pre-SOX back in 2001. As the article summarizes:

FPL directors scrutinized payment plans. They clashed with executives. Shareholders sued. After three years and millions in legal bills, executives returned $9 million, based largely on a technicality. Insurers paid another $12.5 million. The FPL saga is an object lesson in why companies rarely recoup money paid to executives for results they didn't actually achieve. Although the concept seems simple, at least from an ethical point of view, so-called "clawbacks" of executive pay are in practice disruptive, divisive and difficult to pull off. In addition to a murky legal environment, the process is complicated by compensation contracts and insurance provisions. Most boards don't try recovering the money. Those that do often get mired in years of litigation.

The article points out that the company basically got nothing back because of the accounting miscalculation.

And the WSJ notes there will be more such cases: "With beefed up scrutiny of corporate accounting, an increasing number of companies have been revising their numbers, making the clawback problem more acute."  Every time a company restates because of, say, backdating, there's a basis for recomputing all of their executives' accounting-based compensation.  Something for firms to consider if they think that bonuses are now safer than stock options. 

In addition to the problem that the executives may not have been responsible for the miscalculation, the article discusses how hard it may be to calculate the over-payment:

Even voluntarily returning money can prove complicated. After a 2002 restatement shaved $100 million from Dollar General Corp.'s net income for 1998 to 2000, the discount retailer's then-CEO, Cal Turner Jr., decided to return all of his bonuses. But his awards also included the right to exercise stock options ahead of schedule -- and the value of the shares he bought had fallen below what he'd paid for them.

Perhaps there's a problem here – but there are worse problems with Congress wading in to try to solve it. Executive compensation is a matter best handled by individual firms under state law and contract. As the WSJ article shows, firms themselves have been adopting provisions more precisely targeted at executive misconduct, sometimes prodded by shareholders.

Nevertheless, the article suggests that the problems haven't deterred Congress:

Rep. Barney Frank, the Massachusetts Democrat who's in line to become chairman of the House Financial Services Committee, has proposed legislation that would strengthen the ability of shareholders to achieve clawbacks.

In other words, bad enough that the companies themselves have had problems dealing with this, now plaintiffs' lawyers may get a crack at it. No doubt the "shareholders" will appreciate their companies going through more senseless ordeals like what the WSJ calls "the saga at FPL."

Comments

[save_the_rustbelt]

So if I get a bonus or options based on fraudulent accounting, I should keep the bonus because returning it would be inconvenient?

Wow.

Maybe all fo the high priced compensation consultants and lawyers who are supposed to be serving the interests of the company could add something to those fabulous contracts.

I guess us rubes just don't understand what happens in the big leagues.

[Sam E. Antar (former Crazy Eddie CFO & ex-felon)]

I am quite sure that Professor Ribstein is not advocating that an ex-felon like me should have my 5 year employment agreement enforced with his former employer whose shareholders had been defrauded as a result of my actions.

If the change in earnings calculations that many employment agreements are based is a result of statutory changes in accounting principles rather than fraud I can understand his point.

Respectfully,

Sam E. Antar

[Sam E. Antar (former Crazy Eddie CFO & ex-felon)]

To add an additional comment, if the restatement in earnings is a result of fraud (then the previous earnings where fictitious) and the goals of the earnings based compensation was never achieved.

In such case, the money earned based on fictitious earnings should be returned.

Respectfully,

Sam E. Antar