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.
We are excited to bring our popular “Meet the Speaker” series back to the NASPP Blog, featuring interviews with speakers at the 22nd Annual NASPP Conference. This is a great way to get to know our many distinguished speakers and find out a little more about their sessions in advance of the Conference.
For our first Meet the Speaker interview, we feature Mike Andresino of Posternak Blankstein & Lund, who will moderate the session “10b5-1 Plan Twists & Turns.”
NASPP: What is the most critical thing NASPP Conference attendees need to know about Rule 10b5-1 plans?
Mike: If your company does not yet use 10b5-1 plans as part of its insider compliance program, you are missing out on an important tool. If you do use these plans, there are important best practices that companies ignore at their peril.
NASPP: What are some best practices companies should implement for 10b5-1 plans?
Mike: Companies need to address, up-front, the expectations that plan participants should have regarding issues such as suspension, amendment or termination of 10b5-1 plans, SEC disclosure of their plans, price targets and other hot button issues that are not addressed in the 10b5-1 regulations but are part of the administrative environment for the plans.
NASPP: What is the worst horror story you have heard about a 10b5-1 plan gone wrong?
Mike: Angelo Mozilo, former CEO of Countrywide Financial, agreed in 2010 to a $67.5 million settlement with the SEC over charges that he abused his 10b5-1 plans for trading gains. If I’m trying to get directors and officers to pay attention to compliance issues, sixty-eight million bucks will usually do it!
NASPP: And last, just for fun, if you had a store on Etsy, what would you sell in it?
Mike: One word–Marinade! More specifically, I would bottle and sell a marinade that I use for salmon and other fish, that uses oil, soy sauce, honey and dark rum. Maybe I would package it in a kit with the rub I use. Hmm, now I just need a good design for the bottle….
We think of SEC documents as a snore, but the complaints issued by the SEC’s enforcement division can be more interesting than you think. Today I look at a recent complaint related to insider trading that illustrates how important it is to make sure employees understand the laws in this area.
In the complaint (SEC vs. Toby G. Scammell), the SEC alleges that Toby Scammell, an employee of an investment fund, found out about Disney’s acquisition of Marvel Entertainment before the deal was announced publicly (by sneaking a look at his girlfriend’s Blackberry), purchased call options on Marvel, and then sold them at a 3,000% profit after the deal was announced.
This is a good case for me to write about because, as far as I can tell from the complaint, Disney wasn’t in any way at fault for this. Scammell didn’t work for Disney and his girlfriend, who did work for Disney as an extern, didn’t voluntarily give the information to him. So I don’t have to suggest that an NASPP member had less than perfect procedures (I’m sure all of you are perfect anyway).
There are many things that are interesting about this case and there’s definitely some entertainment value in reading the complaint (or at least the SEC’s summary of it). What I find most interesting is that Scammell isn’t some high level executive or celebrity (a la Martha Stewart) and, although he realized a 3,000% profit, his investment apparently wasn’t that much to begin with, because that only worked out to around $200,000. On the surface, the whole thing hardly seems worth the SEC’s time, but not only is the SEC pursuing the case, it has garnered a fair amount of attention from the media.
And this is exactly why you have an insider trading compliance policy and why you want to make sure all your employees, not just your executives, understand it. Even if your employees aren’t subject to black-out periods and don’t regularly have access to material, non-public information, it is important that they understand what insider trading is, that it is prohibited by law, what the penalties could be, and your company’s insider trading compliance policy. You just never know what someone is going to overhear or come across–a confidential document could be left out on a copier, for example.
Insider Trading = Bad News for Everyone
Here’s why you don’t want your employees to be prosecuted for insider trading:
It’s bad news for your employees. They could pay stiff penalties to the SEC and/or face criminal prosecution (and have to pay back all the money they made on the trades, of course). They might also end up being fired for cause, since this is a common provision in insider trading compliance policies. Even if they aren’t guilty–and Scammell has been vocal about professing his innocence–their legal fees are likely to be significant (unless they opt for a public defender).
It’s bad news for the company–literally. The SEC prosecuting your employees for insider trading is likely to generate a lot of unwanted media attention, as evidenced by the flurry of articles, blogs, etc. on this case (which I am now contributing to).
It’s more bad news for the company. If the SEC is successful in prosecuting your employees for insider trading, then they could potentially focus their attentions on the company as well. Your insider trading compliance policy demonstrates that you actively discouraged employees from insider trading and could protect the company from an SEC enforcement action.
Your insider trading compliance policy is not just ceremonial or a formality. It is an important policy that protects both the company and its employees. A key part of your stock plan education program is to make sure employees understand this policy, even if they aren’t subject to black-out periods, and understand the types of transactions that are prohibited by law and by your policy.
For more information on insider trading compliance polices, check out this month’s Compliance-O-Meter quiz.
NASPP “To Do” List We have so much going on here at the NASPP that it can be hard to keep track of it all, so I keep an ongoing “to do” list for you here in my blog.