C-Suite clawbacks on the rise

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C-Suite clawbacks on the rise

man in handcuffs

The risk of unintentional fraud charges may be rising for senior executives whether they actually commit fraud themselves or not. The SEC has been gradually broadening their interpretation of Section 304(a) of the Sarbanes-Oxley Act of 2002 using the term “misconduct” referring to behavior that leads to restated financial statements.

Prior to 2009, these cases were brought against the CEO and CFO only when the executives themselves engaged in “intentional and pervasive accounting fraud”, according to Junaid Zubairi, chair of the government enforcement and special investigations group at law firm Vedder Price.

The SEC has successfully used Section 304(a) to clawback compensation in cases where executives were not personally engaged in the fraud but were held accountable nonetheless. In an interesting twist, CFOs are under fire even after they leave the firm in “innocent-executive” cases although none have resulted in convictions at this point.

Now for the bad news! The SEC may expand its use of 304(a) further to include “negligence-based cases without regard to fraud”.

According to Zubairi, who was an attorney with the SEC’s enforcement division before joining Vedder Price in 2008. “As the SEC staff has made clear in litigation filings and during the investigative phases of these matters, there are ongoing discussions about whether mere negligence is enough to trigger a clawback, and the staff is taking the position that it is.”

Apparently, these cases have not yet included members of the board, internal audit, chief compliance or chief risk officer however firms such as J.P. Morgan exercised its right to clawback compensation from those individuals held responsible for its $6 billion loss in the “Whale Trade.”

The best offense may be a good defense.

Firms with strong internal controls, including disclosure of the operation of controls and a formal process for monitoring fraud and other key controls may fair better than firms lacking robust systemic controls. The SEC has broad authority to determine enforcement action with consideration given for minor infractions and substantive evidence of an effort to create a culture of compliance.

The SEC’s more aggressive stance on Section 304(a) may be the result of the public outcry to hold executives accountable for mortgage fraud and other unethical behavior. Whatever the reason, Section 304(a) may become the most troubling enforcement tool used by the SEC to hold senior executives accountable for unethical behavior. There is no more compelling reason for the CEO and CRO to work together to build a culture of compliance.

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