SEC Taking More Aggressive Stance on CEO Clawbacks

The SEC is pursuing a rather odd case, odd in the sense that while the media is getting very excited about it, it strikes me as having perilous little general applicability.

The broad strokes via the Financial Times:

The US Securities and Exchange Commission’s attempt to use – for the first time – a “clawback” law against an executive who is not accused of any wrongdoing marks a new hard-hitting approach at an agency under pressure to restore its reputation.

Until now, the SEC used the provision in the 2002 Sarbanes-Oxley law to go only after individuals it had accused of being involved in fraud and, even then, made its first settlement invoking that law some five years after it was adopted…

The clawback provision in Sarbanes-Oxley, passed in the wake of massive accounting frauds at Enron, Worldcom and other companies, requires executives to return performance-based pay and bonuses as well as stock sale profits if a company is forced to issue an accounting restatement “as a result of misconduct”.

Last week, the regulator asked a court to order the return of $4m (€2.82m, £2.43m) paid to Maynard Jenkins, former chief executive of CSK Auto, whose profits were allegedly inflated by accounting fraud committed by others: Mr Jenkins was not involved….

Yet it is far from clear whether the agency will be successful. The structure and language of the provision, known as Section 304, are ambiguous and have already prompted debate among lawyers.

Some questions, such as whether the provision could be used by private litigants, were partly resolved when courts ruled that only the SEC could enforce it. Private lawsuits invoking the provision have continued to be filed nonetheless.

“It has always been an open question whether the SEC would use this weapon against a CEO or CFO who did not personally engage in misconduct, and whether such an aggressive claim would be sustained in litigation,” wrote Wachtell, Lipton, the big Wall Street law firm, in a memo criticising the SEC action.

“They are basically going for the strict liability standard,” said Mr Salehi. The SEC has interpreted every ambiguity in the law in the “most aggressive way possible and saying this is the way the ambiguities are going to be resolved”.

OK, I hate to sound dense, but how often do you have fraud cases where the accounting was so distorted that the SEC could argue that a clawback was warranted (that is, the profits were boosted enough that it made a big difference in the bottom line, hence the CEO’s pay) AND the CEO was not in on it?

To put it another way, isn’t there another theory for going after the CEO? It strikes me he would have had to be pretty derelict in duty for a fraud to go on long enough to have a big impact and him not notice that something was amiss. He clearly failed in his duty of care to the corporation and its shareholders. And if his comp was inflated due to phony profits, there is a clear philosophical and policy reason to try to recoup the excesses. It’s a sign of how badly (or more accurately, CEO servingly) that incentive comp is structures that it fails to contemplate and address this possibiility.

Perhaps I am missing something, but I don’t see an SEC victory as significant, in terms of number of cases that there might be in the future like this.

Where this MAY be significant is that it shows that the SEC is willing to be very aggressive in how it reads ambiguities in the regs. But is this really the best use of SEC firepower? I’d much rather see them get creative about verbal misrepresentations in the selling of complex instruments. But many of those were derivatives and hence outside the SEC’s reach.

But the FT thinks otherwise, so perhaps I am wrong here:

“They are taking this tool and interpreting it aggressively. If they are successful, I expect to see them using it often and I bet it would change the way CEOs and CFOs behave when it comes to restatements, though it may also make people even more reluctant to take those jobs,” said Nader Salehi, a partner at Bingham, the law firm.

Yves again, Um, this is hardly a common type of restatement, and I love the notion that it’s hard to find people to take CEO jobs. Please. There are plenty of highly skilled division executives who’d make good CEOs. The problem is that boards (and the search firms that advise them, since a more difficult recruitment justifies the search firm fees) want CEOs from central casting, ideally someone who is a CEO somewhere else.

Print Friendly, PDF & Email


  1. attempter

    As someone who looks at these things purely politically (since that's all they really are), it seems to me that if regulators really were willing to aggressively use this approach, it could be used pretty much anywhere against these financial entities, all of whom are involved in accounting fraud.

    (What's the whole point of the bailouts, other than to let these banks get away with fraudulent valuations of worthless "assets", and, if the administration could politically manage it, to force the taxpayers to buy at these fraudulent valuations?

    And what's the whole point of the business press, other than to trumpet fraudulent "profit" reports from these banks, based on other accounting improprieties?)

    So I can't imagine where you could fail to find opportunites. It's a target-rich environment.

    And I love the concept of strict liability, given how the whole point of incorporation is to absolve actors of liability for their actions, i.e. to place criminals above the law.

    But the whole thing boils down to the big "if", if they really intended to use this in a systematic way. And I agree there's no reason to believe they would.

    So I guess the media hype is another pretense that something is being done when it's really not.

    Hype would be warranted when they used something like this to claw back that laundering of public money to Goldman via AIG.

  2. fresno dan

    There are posts that you have had on this blog about "looting."
    However, I am more inclined toward an enven more radical view of the stock market – that the theory that we are rational players selecting CEO's on their ability to manage the company is all hooey.
    When something like 30% (or was it 60%) of all profit goes to the CEO of a bank, the risk reward for owning stock just doesn't make sense. The CEO's are acting rationally – they may not know how to run a bank, but they know how to get compensated. The question is: why do shareholders put up with this? Speaking for myself, I thought I was well informed – stocks give the best return in the long term – yeah, if only I had a 150 year lifespan.

  3. Yves Smith


    I must beg to differ with you here.

    No one has proven accounting fraud at the financial firms, and AS A MATTER OF POLICY no on is willing even to mention the F word.

    Remember, mission number one is keeping bank stocks up so they can float new shares to chumps. Confidence is the order of the day. Lehman looked like a pretty clear cut case of fraud, and here we have Bryan Marsal, effectively head of the Lehman windown operation, bothering to go on the media to say the losses were entirely due to the disorderly unwind. If you believe that, I have a bridge I'd like to sell you.

    And the fact case here is very specific: the fraud was big AND : the CEO was unaware of it. Do you think that applied on Wall Street?

  4. skippy

    SEC who? Ohh yeah the Regulators.

    Did their prince kiss them and awaken them from their slumber or did the coffee haven/great deli on the corner close up, leaving them with out reward stimulus. I'll leave that question for readers to ponder.

    Yves said…The problem is that boards (and the search firms that advise them, since a more difficult recruitment justifies the search firm fees) want CEOs from central casting, ideally someone who is a CEO somewhere else.

    Skippy..Now, what would replace the traditional alpha male/female hormonal victory chest beating upon a successful headhunting foray…complete w/ drinks at the bar rectum polishing session, all hail the conquering chieftain
    toast, "be gentle its my first time like that". With out blood, there is no Victory!

    PS. Habits never die, just replaced.

  5. attempter

    Yves, I never believe the CEO is unaware of it, ever.

    But wouldn't that be even more clearly culpable and actionable? I thought what was new here was the potential tool of imposing strict liability. That way you wouldn't have to prove anybody's knowledge and "intent". (And why should we have to? If any of these CEOs are worth one tenth of what they get paid, they can be assumed to have all the competence necessary to detect any fraudulent practice. Strict liability, absolutely.)

    Like I said, I agree completely, it's against policy to acknowledge fraud or the possibility of fraud, and that's why I agree it seems far-fetched that there will be any there there in practice.

    I was just ruminating on what could be, if a US government ever did miraculously decide to act in the public interest. In that case this sounds like it could be a useful tool.

  6. Peripheral Visionary

    Yves, on CEO selection, I totally agree. But this is, in my view, a symptom of the shift in hiring practices, from the old-school system controlled by the hiring manager (or for CEO, the firm's owners) to the new HR-centric system, or for CEOs, the executive search committee.

    The HR- and committee-based systems are considered "better" than the older system because they are more even-handed and less influenced by personal connections; there is (in theory) less patronage and nepotism inherent in the process. But the downside is that they are very risk-averse; since one of the ostensible reasons for the new approach is to limit liability, they have a strong tendency to play it safe.

    And they play it safe by hiring people for jobs who have already done that job. I have seen it many times: the job description which basically asks for someone who has already done the job in question.

    Ironically, that ostensibly "fair" approach has resulted in a deeply unfair system, where it's nearly impossible to break into the top ranks of management, but that once somebody has broken that barrier, they get offer after offer with complete disregard for their actual competency (case in point: Bob Nardelli.) I see the exact same thing in politics: once people have risen to a certain level, they get appointment after appointment, with complete disregard for their actual competency. All that matters is that they've done it before; how well they've done it gets little attention.

    That can be fixed, but to do so would be to abandon HR orthodoxy, which calls for hiring practices that are focused on getting the "most qualified" person possible. Instead, it would need to be recognized that the best person for the job might actually be somebody who is not currently qualified, but who can be brought up to speed while in the position–as happened routinely under old patronage-based hiring systems (e.g. partnerships, where rather than going outside the firm for a new partner, an existing member of the firm would be "groomed" for an upcoming partnership position.)

    Again, that would mean abandoning much of the current recruiting "best practices", but some changes are needed to break down the barriers between levels of management that amount to welfare for incompetent managers and barriers to entry for competent employees.

  7. Anonymous

    I don't know, Yves… some CEOs are operators and try to leave the accounting aspects to the numbers wizards. If the CFO says everything is fine, and the auditors say everything is fine, well… a CEO has other things to think about.

    I'm not saying that necessarily happened here, but the fact that a major accounting fraud has occurred in a company isn't in and of itself evidence that the CEO was in on it.

  8. Anonymous

    Anon above said: " If the CFO says everything is fine, and the auditors say everything is fine, well… a CEO has other things to think about."

    I would buy this arguement anywhere but in the financial industry….which is what is being talked about.


Comments are closed.