October 21, 2021

Volume XI, Number 294

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SEC Continues to Regulate and Claw Back Incentive-Based Compensation

Three recent events have reiterated the SEC’s commitment to regulate and potentially claw back incentive-based compensation paid to executives in various industries.  On March 2, 2011, the SEC released a proposed rule that would require certain financial institutions to disclose the structure of their incentive-based compensation practices and prohibit such institutions from maintaining compensation arrangements that “encourage inappropriate risks.”  The following day, the SEC announced yet another settlement with an “innocent” CEO to claw back all incentive-based compensation the CEO received during a restatement period.  Most recently, on March 24, 2011, the SEC and former CSK Auto Corporation CEO Maynard L. Jenkins announced a tentative settlement of the SEC’s clawback lawsuit against Jenkins.

Proposed Rule on Disclosure of Incentive-Based Compensation Arrangements at Financial Institutions

Pursuant to Section 956 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, the SEC recently proposed a rule to regulate the incentive-based compensation practices of certain financial institutions with $1 billion or more in assets.  The covered financial institutions include broker-dealers and investment advisers.  The proposed rule would:  (1) require covered financial institutions to file annual disclosure reports related to incentive-based compensation; (2) prohibit incentive-based compensation arrangements that encourage inappropriate risk-taking by providing excessive compensation or that could lead to material financial loss to the firm; and (3) require covered financial institutions to develop policies and procedures to ensure and monitor compliance with the above-stated requirements related to incentive-based compensation. 

In addition, for financial institutions that have $50 billion or more in assets, the SEC’s proposed rule would require possible deferral of incentive-based compensation for executive officers and approval of such compensation for people whose job functions give them the ability to expose the firm to a substantial amount of risk.

The SEC’s proposed rule confirms its commitment to regulate and curb incentive-based compensation paid by various financial institutions.  The rule should be available in the Federal Register for public comment soon.  Once the rule is published in the Federal Register, the public will have 45 days to comment.

Continued Clawback of Incentive-Based Compensation Pursuant to SOX Section 304

In addition to its regulation of the financial industry, the SEC continues to claw back incentive-based compensation from certain CEOs and CFOs in various other industries.  Recently, the SEC again used Section 304 of the Sarbanes-Oxley Act as a powerful, independent cause of action in order to obtain reimbursement of bonuses and other incentive-based and equity-based compensation from an executive—without charging the executive with any personal wrongdoing.

On March 3, 2011, the SEC announced a settlement with Ian McCarthy, the CEO of Atlanta-based homebuilder Beazer Homes.  The SEC brought a complaint against Mr. McCarthy under Section 304 for failure to reimburse Beazer for cash bonuses, other incentive-based or equity-based compensation, and profits from Beazer stock sales that Mr. McCarthy received during the 12-month period after Beazer filed allegedly fraudulent financial statements for fiscal year 2006.

Beazer and its chief accounting officer were previously charged for their involvement in a fraudulent earnings management scheme to artificially inflate Beazer income and earnings during its fiscal year 2006.  Mr. McCarthy was not personally charged with any misconduct.  Nevertheless, the SEC filed a complaint seeking to claw back any incentive-based and equity-based compensation that Mr. McCarthy received during the restated period.  Mr. McCarthy chose to settle with the SEC and agreed to reimburse Beazer for nearly $6.5 million in cash, 40,103 restricted stock units and 78,763 shares of restricted stock.

Finally, on March 24, 2011, the SEC and Maynard L. Jenkins—the former CEO of CSK Auto Corporation—announced a tentative settlement of the SEC’s lawsuit against Jenkins and requested a stay of the ongoing proceedings in SEC v. Jenkins, 09-cv-1510, U.S. District Court, District of Arizona.  In 2009, the SEC brought the clawback lawsuit against Jenkins pursuant to Section 304, seeking to claw back more than $4 million in bonuses and other incentive-based and equity-based compensation from Jenkins, without alleging that he engaged in any personal misconduct.  Jenkins initially attempted to litigate the case and unsuccessfully sought to dismiss the SEC’s Section 304 claims.  However, according to recent court filings, the court expressed concern about the increased indemnification costs CSK Auto Corporation would incur as the Jenkins lawsuit continued.  It now appears that the SEC and Jenkins wish to settle to avoid incurring additional legal costs in this matter.  By order dated March 25, 2011, all filings in the Jenkins case are stayed pending approval of the settlement by the SEC Commissioners.  The parties have until May 25, 2011 to file a proposed stipulation of dismissal pursuant to settlement, or to issue a joint status report if the settlement is not finalized and accepted.  The terms of the tentative settlement are nonpublic until approved by the SEC Commissioners.

These recent actions and settlements reinforce the SEC’s willingness to proceed against CEOs and CFOs under Section 304, even in the absence of any alleged misconduct by those executives.  Now more than ever, corporations and executives should re-examine the benefits and drawbacks of performance-based compensation in light of the SEC’s recent and repeated use of Section 304 against executives.  Moreover, the SEC’s use of Section 304 should be viewed as an incentive for senior executives to foster a culture of compliance and be particularly mindful of financial reporting requirements.

© 2021 Vedder PriceNational Law Review, Volume I, Number 92
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About this Author

Thomas P. Cimino, Vedder Price Law Firm, Litigation Attorney
Shareholder

Thomas P. Cimino, Jr. joined Vedder Price P.C. in 1996 as a shareholder and is a member of the firm’s Litigation Practice Area. He has broad experience in complex commercial litigation, including securities fraud class actions, shareholder disputes, patent, trademark and copyright infringement and bankruptcy litigation.  Mr. Cimino has appeared in both state and federal trial and appellate courts throughout the United States. He also has represented clients in proceedings before the United States Securities and Exchange Commission.

312-609-7784
Junaid A. Zubairi Vedder Price Law Firm  Government  Investigations Attorney
Shareholder

Junaid A. Zubairi focuses his practice on government investigations, investment services and regulatory compliance matters.  His practice includes representing companies and individuals in SEC investigations, conducting internal investigations, counseling clients during regulatory examinations, and providing general compliance and remediation counseling.  Mr. Zubairi has extensive experience representing investment advisers, broker-dealers, corporations and officers and directors during government investigations and regulatory proceedings.

Mr. Zubairi regularly practices before the...

312-609-7720
William Thorsness, Corporate Litigator, Vedder Price legal practice
Shareholder

William W. Thorsness joined Vedder Price as an associate in the Litigation Practice Area. In this capacity, Mr. Thorsness represents and counsels corporations and individuals on all litigation concerns, including contract, commercial and tort matters. In 2007, Mr. Thorsness also became a member of Vedder Price’s Bankruptcy Group. As an associate in Vedder Price’s Bankruptcy Group, Mr. Thorsness focuses his practice on corporate bankruptcy, reorganization and workouts.

312-609-7595
Rachel T. Copenhaver, Vedder Price Law Firm, Litigation Attorney
Shareholder

Rachel T. Copenhaver joined Vedder Price P.C. as an associate in the Commercial Litigation Practice Area.  She counsels and represents clients on a wide variety of business and commercial disputes, including contract, commercial and tort litigation.

312-609-7514
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