On November 13, 2012, a federal district court in Austin, Texas, denied a motion to dismiss in the Securities and Exchange Commission's (SEC) Sarbanes-Oxley Act (SOX) Section 304 clawback suit against two former executives of a corporation. The suit, Securities and Exchange Commission v. Michael A. Baker and Michael T. Gluk (Case No. A-12-CA-285-SS), was filed by the SEC in April to attempt to recover bonuses and stock sale profits received by the former CEO of the corporation, Michael A. Baker, and the former CFO, Michael T. Gluk, after the corporation filed false financial statements due to accounting fraud.
SOX Section 304 requires reimbursement by CEOs and CFOs of certain compensation and stock sale profits received if their company is required to restate financial statements due to material noncompliance, as a result of misconduct, with any financial reporting requirement under the securities laws. In their motion to dismiss, the defendants argued that SOX Section 304 should be read to require personal misconduct by a corporate officer himself and that SOX Section 304 is unconstitutional.
Even though the defendants were not charged with personal misconduct in this case, the court found that the SEC had stated a claim for which relief could be granted, holding that SOX Section 304's reimbursement requirements can apply to executives that have not been personally charged with wrongdoing. The court also upheld SOX Section 304 as constitutional despite challenges by the defendants. In his opinion, Judge Sam Sparks stated:
Apologists for the extraordinarily high compensation given to corporate officers have long-justified such pay as asserting CEOs take 'great risks,' and so deserve great rewards. For years, this has been a vacuous saw, because corporate law, and private measures such as wide-spread indemnification of officers by their employers, and the provisions of Directors & Officers insurance, have ensured any 'risks' taken by these fearless captains of industry almost never impact their personal finances. In enacting Section 304 of Sarbanes Oxley, Congress determined to put a modest measure of real risk back into the equation. This was a policy decision, and while its fairness or wisdom can be debated, its legal effect cannot. Section 304 creates a powerful incentive for CEOs and CFOs to take their corporate responsibilities very seriously indeed.
In addition to providing support for SEC action under SOX Section 304, the decision has implications for SEC action under certain provisions of the Dodd-Frank Act. Particularly, Section 954 of the Dodd-Frank Act will expand the pool of executives that may be subject to clawback actions from CEOs and CFOs to all current and former executive officers. It also will require listed companies to develop and implement policies providing for the recoupment of incentive-based compensation in the case of accounting restatements caused by material noncompliance with financial reporting requirements under the securities laws.
Here is the federal district court's opinion in Securities and Exchange Commission v. Michael A. Baker and Michael T. Gluk.