The SEC continues to aggressively use section 304 of the Sarbanes-Oxley Act (“Section 304”) as an independent cause of action in order to obtain reimbursement of bonuses and other incentive-and equity-based compensation from an executive— without charging said executive with any personal wrongdoing. On August 30, 2011, the SEC announced yet another settlement with an “innocent” executive to claw back the executive’s bonuses, incentive-based and equity-based compensation, and profi ts realized from stock sales during the relevant time period.
Further, a Section 304 litigation claim may continue against another “innocent” executive, Maynard L. Jenkins, after Jenkins and the SEC recently informed the court that their settlement discussions were unsuccessful.
SEC v. James O’Leary, CPA
On August 30, 2011, the SEC announced a settlement with James O’Leary, the former chief fi nancial offi cer of Beazer Homes USA, to recover O’Leary’s bonus compensation and stock sale profi ts from the period during which Beazer Homes committed an alleged accounting fraud.1 This settlement is similar to the settlement announced in March 2011 between the SEC and Ian McCarthy, former chief executive offi cer of Beazer Homes, which required McCarthy to reimburse Beazer Homes pursuant to Section 304.
Beazer Homes and its former chief accounting offi cer Michael Rand were previously charged for their involvement in a fraudulent earnings management scheme to artifi cially infl ate Beazer’s income and earnings during its fi scal year 2006. Beazer settled an enforcement action in 2008. Litigation continues against Rand, who is charged with violations of Section 17(a) of the Securities Act of 1933, Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder, among other things.
The SEC’s complaint against O’Leary—like the complaint against McCarthy—does not allege that O’Leary engaged in any wrongdoing. However, because of the “misconduct” of Beazer Homes and Rand, the SEC argued that Section 304 required O’Leary to reimburse Beazer Homes for bonuses, incentive-and equity-based compensation and profi ts realized from sale of stock.
SEC v. Jenkins
SEC v. Jenkins, fi led in July 2009, was the SEC’s fi rst attempt to claw back incentive-based compensation from an executive without also alleging wrongdoing by the executive. The parties engaged in extensive litigation and motion practice, and the District Court expressed concern about the increased indemnifi cation costs CSK Auto Corporation (“CSK”) (Jenkins’s former employer) would incur as the Jenkins lawsuit progressed. Indeed, in January 2011, CSK informed the court that it had already been billed “approximately $1.9 million in legal fees and costs associated with Mr. Jenkins and $1.5 million since litigation commenced.” Those costs have been covered by an insurer for CSK. In order to avoid further litigation costs, on March 24, 2011, the SEC and Jenkins announced a tentative settlement. However, on July 18, 2011, the SEC staff notifi ed the District Court that the parties were unable to come to a fi nal agreement.
The rejection of the Jenkins settlement likely will renew litigation in the Jenkins case, including litigation regarding the SEC’s pending partial motion for summary judgment. In September 2010, the SEC moved for partial summary judgment, alleging that there were no issues of material fact regarding the fi rst three elements of Section 304 liability: (1) whether CSK was required to prepare an accounting restatement; (2) whether that restatement was due to CSK’s material noncompliance with any fi nancial reporting requirement under the securities laws; and (3) whether CSK’s noncompliance was due to misconduct.2 Notably, in its briefs in support of partial summary judgment, the SEC argued that the term “misconduct” in Section 304 should be interpreted by its “common meaning” and should be defi ned as “improper or unacceptable behavior.”3 The SEC went on to argue that, “since ‘gross negligence’ is typically defi ned to mean ‘willful misconduct,’ it stands to reason that since there are no equivalent modifi ers in front of the word “misconduct” in Section 304 that negligent conduct suffi ces.”4
The partial summary judgment motion was briefed at the end of 2010 and supplemented in February 2011, but it was never decided. If this case continues in litigation, the SEC’s motion for partial summary judgment may be refi led and reviewed by a new judge, the Hon. Robert J. Bryan, who replaced the Hon. G. Murray Snow on February 22, 2011.