The NASPP Blog

February 19, 2016

A CFO’s (Non) Misconduct Brings Clawback Under SOX

This week the SEC announced a settled enforcement action against the former CFO of Marrone Bio Innovations, Inc. At issue were bonuses the former CFO received within 12 months of various financial filings containing results that the company was later required to restate. Using Section 304 of the Sarbanes-Oxlely Act of 2002 (SOX 304), the SEC pursued the clawback of $11,789 in bonuses from the former CFO.

As we await final clawback rules from the SEC (which originate from Dodd-Frank and would apply to national securities exchanges), it’s important to remember that the SEC already has the present ability to enforce clawbacks in certain situations under SOX 304. The SOX provisions apply only to CEOs and CFOs and the courts have determined that only the SEC has the power to enforce clawbacks under SOX. One common misunderstanding about SOX 304 centers on “misconduct.” A Latham & Watkins memo once described SOX 304 as follows: “The statute states that, in the event an issuer is required to prepare an accounting restatement caused by “misconduct,” the CEO and the CFO “shall” reimburse the company for any bonus or other incentive-based or equity-based compensation, and any profits from the sale of the issuer’s securities, received during the year following the issuance of the misstated financial statements.” The memo later explained that the misconduct does not necessarily need to be on the part of the CEO or CFO who is subject to the clawback, a fact sometimes overlooked in our view of the type of misconduct that would trigger a clawback.

The recent SEC enforcement in the case of the former MBI CFO is a prime example that the SEC appears to have determined the misconduct by someone or something other than the person subject to the clawback (the CFO) as a legitimate grounds to demand the repayment of the CFO’s compensation. In this case, the former CFO had to return $11,789 in bonuses, but the SEC did not allege misconduct on his part. They did, however, allege that by not voluntarily returning his incentive compensation once the restatements occurred, he had violated SOX 304. It’s important to understand that in order for the circumstances for a clawback to be ripe, misconduct specifically by the CEO or CFO does not need to be present. Misconduct by someone or something else leading to a restatement can be enough to require the clawback of incentive compensation under SOX 304.

It’s important for companies to evaluate the circumstances regarding any restatement to ensure that appropriate measures have been taken to clawback the appropriate compensation from the CEO and CFO under SOX 304.

The SEC’s proposed clawback rulemaking resulting from Dodd-Frank will require national securities exchanges to adopt standards that, among other things, expand the scope of clawbacks – making them applicable to more individuals and for a longer period of time. The types of compensation subject to the clawback will be more limited under the proposed rules. These rules will not replace SOX 304; the SEC can still continue to rely on SOX 304 as means to enforce clawbacks. For full details on the proposed rules, visit the NASPP Alert on this topic.

-Jenn