‘They’re Going to Go After the Leadership’

The SEC is seeking, through its enforcement actions, to shape the behavior of high-ranking executives, and it plans to do so by targeting their bonuses when their firms engage in wrongdoing.

SEC officials signaled at the SEC Speaks conference last week that they’re pursuing more aggressive use of a section of the Sarbanes-Oxley Act that empowers the commission to claw back certain compensation bonuses and stock-sale profits from CEOs and CFOs when their firms have to re-issue an accounting statement because of misconduct.

The portion of the statute, known as Section 304 or SOX 304, does not require the CEO or CFO to be personally liable for the misconduct that gave rise to the restatement; it only requires them to have presided over a firm where misconduct took place, a fact SEC officials pointed out to an audience of securities enforcement lawyers last week.

“These orders provide a form of public accountability for senior executives who presided over a firm at which misconduct occurred that required their firms to restate their financials,” SEC Deputy Enforcement Director Sanjay Wadhwa said at the conference. “And by requiring these executives to reimburse the company for certain types of compensation and profits from stock sales, these SOX 304 orders further incentivize senior executives to prevent and detect misconduct at their firms.”

Sam Waldon, the chief enforcement counsel at the SEC and a former Proskauer Rose partner, said the purpose of the orders was to “incentivize CEOs and CFOs to implement robust internal controls over financial reporting and to establish and maintain an appropriate tone at the top.”

Walton noted that the SEC would seek the “full amount of the reimbursement that is required by the statute,” and not just the amount of additional compensation the CEO or CFO may have received as a result of the misconduct. He pointed to two recent SEC settlements, Granite Construction and Synchronoss Technologies, in which the SEC clawed back more than $1 million in bonuses and stock-sale profits from the companies’ respective CEOs. In the Granite case, announced last month, the commission also forced two former CFOs to return bonus compensation in a reporting fraud case.

The enforcement tool is not new, but Christian Schultz, a partner at Arnold & Porter Kaye Scholer who left the SEC in March, said the Biden administration’s approach to SOX 304 is more aggressive than in the past. Previous administrations’ discussions about the clawback provision often focused on bonuses an executive earned as a result of the misconduct, rather than all incentive-based pay earned in the year following a fraudulent filing.

“Enforcement is taking a closer look at gatekeepers, and in this context, that would be compliance personnel and senior legal personnel. CEOs and CFOs, who are most at risk for the SOX 304 clawback, need to ensure that they have strong leadership in compliance, risk management, and in their legal department to ensure they’re thinking carefully and deliberately about the policies and the controls that are being put in place,” Schultz said.

Companies and their executives should undertake proactive risk assessments to ensure they can demonstrate to the SEC that compliance is taken seriously and controls are in place to prevent misconduct. “Enforcement is trying to send a very clear message that they‘re going to be looking at the leadership of a company,” said Arnold & Porter partner Jane Norberg, a former head of the SEC whistleblower office. “They’re looking at the tone set from the top and whether leadership has put proper controls in place—and if they haven’t, they’re going to go after the leadership.”

From: The National Law Journal