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SEC Rift on When to Claw Back Bonus May Leave Policy in Limbo

Luis Aguilar
Luis Aguilar, a commissioner at the U.S. Securities and Exchange Commission, speaks at an SEC meeting in Washington. Photographer: Brendan Hoffman

The U.S. Securities and Exchange Commission is divided over when to seize pay from executives who unwittingly benefit from accounting fraud, a rift that has triggered internal disagreements over cases, according to people with direct knowledge of the matter.

As recently as May, the SEC’s enforcement division was working toward a policy that would have limited so-called claw-back actions to times when the executive is implicated in the violations, according to people with direct knowledge of the matter.

Commissioner Luis Aguilar objected to his colleagues that the plan would hinder the SEC’s ability to recoup pay based on inflated profits, said the people, who declined to be identified because the deliberations weren’t public. Last week, Robert Khuzami, the SEC’s enforcement director, sent an e-mail to agency officials saying he would stop using the preliminary guidelines, the people said.

The Sarbanes-Oxley Act of 2002 gave the SEC power to seize payouts to chief executive officers and chief financial officers at companies that restate earnings “as a result of misconduct.” Congress pushed companies to take similar steps in the new financial-regulatory bill.

“Executives have no rightful claim to money that was paid under a mistake,” said James Cox, a law professor at Duke University in Durham, North Carolina. “A bonus that was premised on numbers that later turned out to be wrong because of fraud is an unjust enrichment.”

$4.1 Million

The SEC’s five commissioners have been arguing over how to use the clawback authority since July 2009, when the regulator demanded that Maynard Jenkins reimburse Phoenix-based CSK Auto Corp. for $4.1 million in incentive and stock-based pay he got as CEO between 2002 and 2006. The case marked the first time the agency invoked the Sarbanes-Oxley clause to seize compensation from an executive not accused of violating securities laws.

Since then the SEC has sent mixed signals. When the SEC in June accused Diebold Inc. of using fraudulent accounting to inflate earnings, the company’s former CEO, Walden O’Dell, agreed to give up more than $470,000 in bonuses, 30,000 shares of stock and options for 85,000 shares. He wasn’t accused of participating in the misconduct.

The SEC in July didn’t claw back pay from Michael Dell after alleging that Dell Inc. misled investors about how it met earnings targets and using fraudulent accounting to pad financial results. Michael Dell, the company’s founder, chairman and CEO, wasn’t implicated in transactions that prompted the computer maker to lower earnings from 2003 through the first quarter of 2007 by $92 million. He agreed to pay $4 million over alleged disclosure violations.


The SEC yesterday invoked Sarbanes-Oxley in recouping more than $2 million of bonuses paid to the CEO and former CFO of Navistar International Corp., a manufacturer of trucks and school buses accused of overstating its earnings. The executives “were causes of Navistar’s internal control violations,” the SEC said in a statement.

The enforcement division’s efforts in May to come up with guidelines ran into objections from Aguilar, a 56-year-old Democrat, the people familiar with the matter said. In protest he began sitting out votes on cases that invoked the Sarbanes-Oxley provision, the people said.

Aguilar and SEC spokesman John Nester declined to comment.

Party Lines

When the SEC used the law in the Jenkins case it split the agency’s commissioners on party lines, people familiar with the matter said at the time.

SEC Chairman Mary Schapiro, 55, a political independent, joined Aguilar and Democrat Elisse Walter in voting to sue Jenkins to recoup bonuses and stock-sale profits he received after other CSK executives allegedly inflated the company’s earnings.

Republicans Kathleen Casey and Troy Paredes opposed the case, arguing that the SEC shouldn’t go after bonuses when an executive didn’t orchestrate a fraud and may not have known it was occurring.

Jenkins, who retired from CSK in 2007, is fighting the SEC. In June, a federal judge in Phoenix rebuffed his efforts to have the case dismissed.

Executives can be forced to “reimburse additional compensation received during periods of corporate non-compliance regardless of whether or not they were aware of the misconduct,” U.S. District Judge Murray Snow wrote in his 15-page decision.

Corporations are eager for clues on the SEC’s standards as the agency pursues a wave of investigations stemming from the financial crisis, said Mark Schonfeld, who stepped down as the head of the SEC’s New York office in 2008.

‘Risk of Abuse’

“A CEO can never know whether his compensation is at risk because somebody, somewhere at the company is doing something wrong,” said Schonfeld, who’s now a partner at Gibson Dunn & Crutcher LLP in New York. “In the absence of some articulated standard there is a pervasive risk of abuse.”

Congress approved the Sarbanes-Oxley Act eight years ago in response to a series of accounting scandals at companies including Enron Corp. and WorldCom Inc. that eroded investor confidence. Lawmakers responding to public fury over Wall Street pay included a stronger clawback provision in the financial-regulation overhaul that President Barack Obama signed last month.

Under the new law, executive officers must return three years of bonuses and stock options “in excess of what would have been paid” when their employers restate financial results because of “material noncompliance” with securities laws.

The law also instructs the SEC to write rules that bar companies from listing shares on stock exchanges if they don’t have guidelines to retrieve pay.

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