Three recent events have reiterated the SEC’s commitment to regulate and potentially claw back incentive-based compensation paid to executives in various industries. On March 2, 2011, the SEC released a proposed rule that would require certain fi nancial institutions to disclose the structure of their incentive-based compensation practices and prohibit such institutions from maintaining compensation arrangements that “encourage inappropriate risks.” The following day, the SEC announced yet another settlement with an “innocent” CEO to claw back all incentive-based compensation the CEO received during a restatement period. Most recently, on March 24, 2011, the SEC and former CSK Auto Corporation CEO Maynard L. Jenkins announced a tentative settlement of the SEC’s clawback lawsuit against Jenkins.
Proposed Rule on Disclosure of Incentive- Based Compensation Arrangements at Financial Institutions
Pursuant to Section 956 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, the SEC recently proposed a rule to regulate the incentive-based compensation practices of certain fi nancial institutions with $1 billion or more in assets. The covered fi nancial institutions include broker-dealers and investment advisers. The proposed rule would: (1) require covered fi nancial institutions to fi le annual disclosure reports related to incentive-based compensation; (2) prohibit incentive-based compensation arrangements that encourage inappropriate risk-taking by providing excessive compensation or that could lead to material fi nancial loss to the fi rm; and (3) require covered fi nancial institutions to develop policies and procedures to ensure and monitor compliance with the above-stated requirements related to incentive-based compensation.
In addition, for fi nancial institutions that have $50 billion or more in assets, the SEC’s proposed rule would require possible deferral of incentive-based compensation for executive offi cers and approval of such compensation for people whose job functions give them the ability to expose the fi rm to a substantial amount of risk.
The SEC’s proposed rule confi rms its commitment to regulate and curb incentive-based compensation paid by various fi nancial institutions. The rule should be available in the Federal Register for public comment soon. Once the rule is published in the Federal Register, the public will have 45 days to comment.
Continued Clawback of Incentive- Based Compensation Pursuant to SOX Section 304
In addition to its regulation of the fi nancial industry, the SEC continues to claw back incentive-based compensation from certain CEOs and CFOs in various other industries. Recently, the SEC again used Section 304 of the Sarbanes-Oxley Act as a powerful, independent cause of action in order to obtain reimbursement of bonuses and other incentive-based and equity-based compensation from an executive—without charging the executive with any personal wrongdoing.
On March 3, 2011, the SEC announced a settlement with Ian McCarthy, the CEO of Atlantabased homebuilder Beazer Homes. The SEC brought a complaint against Mr. McCarthy under Section 304 for failure to reimburse Beazer for cash bonuses, other incentive-based or equity-based compensation, and profi ts from Beazer stock sales that Mr. McCarthy received during the 12-month period after Beazer fi led allegedly fraudulent fi nancial statements for fi scal year 2006.
Beazer and its chief accounting offi cer were previously charged for their involvement in a fraudulent earnings management scheme to artifi cially infl ate Beazer income and earnings during its fi scal year 2006. Mr. McCarthy was not personally charged with any misconduct. Nevertheless, the SEC fi led a complaint seeking to claw back any incentive-based and equity-based compensation that Mr. McCarthy received during the restated period. Mr. McCarthy chose to settle with the SEC and agreed to reimburse Beazer for nearly $6.5 million in cash, 40,103 restricted stock units and 78,763 shares of restricted stock.
Finally, on March 24, 2011, the SEC and Maynard L. Jenkins—the former CEO of CSK Auto Corporation—announced a tentative settlement of the SEC’s lawsuit against Jenkins and requested a stay of the ongoing proceedings in SEC v. Jenkins, 09-cv-1510, U.S. District Court, District of Arizona. In 2009, the SEC brought the clawback lawsuit against Jenkins pursuant to Section 304, seeking to claw back more than $4 million in bonuses and other incentive-based and equity-based compensation from Jenkins, without alleging that he engaged in any personal misconduct. Jenkins initially attempted to litigate the case and unsuccessfully sought to dismiss the SEC’s Section 304 claims. However, according to recent court fi lings, the court expressed concern about the increased indemnifi cation costs CSK Auto Corporation would incur as the Jenkins lawsuit continued. It now appears that the SEC and Jenkins wish to settle to avoid incurring additional legal costs in this matter. By order dated March 25, 2011, all fi lings in the Jenkins case are stayed pending approval of the settlement by the SEC Commissioners. The parties have until May 25, 2011 to fi le a proposed stipulation of dismissal pursuant to settlement, or to issue a joint status report if the settlement is not fi nalized and accepted. The terms of the tentative settlement are nonpublic until approved by the SEC Commissioners.
These recent actions and settlements reinforce the SEC’s willingness to proceed against CEOs and CFOs under Section 304, even in the absence of any alleged misconduct by those executives. Now more than ever, corporations and executives should re-examine the benefi ts and drawbacks of performance-based compensation in light of the SEC’s recent and repeated use of Section 304 against executives. Moreover, the SEC’s use of Section 304 should be viewed as an incentive for senior executives to foster a culture of compliance and be particularly mindful of fi nancial reporting requirements.