I’ve written a lot about over-punishing corporate executives for mistakes in business judgment. This is bad, but there’s something even worse – punishing business executives even when they’re not accused of making a mistake.
This is the effect of SOX Section 304(a), which provides in part:
If an issuer is required to prepare an accounting restatement due to the material noncompliance of the issuer, as a result of misconduct, with any financial reporting requirement under the securities laws, the chief executive officer and chief financial officer of the issuer shall reimburse the issuer for-- (1) any bonus or other incentive-based or equity-based compensation received by that person from the issuer during the 12-month period following the first public issuance or filing with the Commission (whichever first occurs) of the financial document embodying such financial reporting requirement; and (2) any profits realized from the sale of securities of the issuer during that 12-month period.
As Butler and I said in our Sarbanes-Oxley Debacle:
An important effect of SOX is to put an increased burden of the risk of corporate fraud on monitors and gatekeepers such as auditors, lawyers, outside directors, and senior executives. This is true not only of the liability provisions discussed above, but also of provisions like section 304, which requires reimbursement of compensation and stock profits following accounting misstatements, regardless of whether the executive knew of the fraud and even if he exercised all reasonable care in monitoring and instituting controls. This is questionable policy.
This provision hasn’t been used against an innocent executive until now. Bloomberg reports that the SEC is set to announce that it will demand that Maynard Jenkins, former CEO of CSK Auto Corp., forfeit compensation for a fraud perpetrated by others in the company. The Bloomberg article (which also quotes me) says:
Demanding Jenkins forfeit compensation may up the ante for other companies facing potential restatements. “It raises the question of whether this will become a standard enforcement expectation any time there is a restatement,” said Philip Khinda, a former SEC enforcement attorney now in private practice at Steptoe & Johnson LLP in Washington.
One may wonder why this provision hasn’t been used until now. One possible reason is that new SEC Chair Mary Schapiro wants to show that the agency that could ignore Madoff should not be shuffled out of existence in the looming reorganization of financial agencies. At least it has some teeth, even if they get sunk into a wholly innocent executive (or Mark Cuban).
Another explanation is the one forecast in “The Sarbanes-Oxley Debacle”:
While the first major market correction will be painful for investors, SOX will surely turn it into a festival for trial lawyers. Such litigation on this scale should not be confused with shareholder protection. SOX has created a ticking litigation time bomb.
A festival for regulators, too. So the downturn coupled with more aggressive regulators and an open-ended law like SOX should make for an interesting, if toxic, mix.
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