By Robin M. Bergen and Shawn J. Chen 

In a previous post, we addressed the expansion of the SEC’s “clawback” authority under Sarbanes-Oxley Act (SOX) §304, which requires reimbursement of incentive compensation and stock sale profits received by chief executive officers and chief financial officers during the 12-month period following a misstatement due to company non-compliance with financial reporting requirements because of misconduct.  This clawback authority applies to individuals who have not personally been charged with the underlying misconduct or alleged to have otherwise violated the federal securities laws.  In this post we revisit that topic in light of the SEC’s$2.8 million settlement on November 15 with Maynard Jenkins, the former CEO and chairman of CSK Auto Corporation. The Jenkins case was the SEC’s first “no fault” clawback case — Mr. Jenkins was not alleged to have participated in or known about the underlying fraudulent conduct.

Beyond the notoriety of being a no-fault clawback, the case also captured attention because of questions raised by an earlier failed settlement attempt by the SEC staff.  In March of this year, the parties advised the Court that SEC staff and Mr. Jenkins had reached a tentative settlement, subject to approval by the SEC’s commissioners.  However, a majority of the commissioners then rejected the staff’s settlement proposal.  We and others wondered if this rejected settlement signaled that the SEC would increasingly refuse to settle no-fault clawback cases for less than the full amount received by executives.  Settlements in other no-fault clawback actions filed after Jenkins, SEC v. O’Dell, SEC v. O’Leary and SEC v. McCarthy, also suggested this could be the case.  Executives in those actions reimbursed their companies for the full amounts of incentive compensation they received during the twelve months covered by §304.

The recent Jenkins $2.8 million settlement, while still well below the $4.1 million initially sought by the SEC, exceeds the amount rumored in the original settlement.  Though the SEC declined to comment on the Commission’s deliberations on the earlier rejected proposal, press reports indicated that it represented “less than half the amount the SEC originally sought.”  While we suspect the recent settlement reflects a significant increase, it is unclear how much this alone accounts for the Commission’s decision to settle a case it had stated just four months ago it would pursue “vigorously.”

The SEC’s previous record of not using §304 in no-fault cases and public statements by one commissioner suggest that the earlier failed settlement in Jenkins reflected a disagreement within the agency on its future approach to pursuing no-fault clawbacks.  Though it had been available since 2002 when SOX was enacted, until Jenkins in 2009, SEC enforcement staff had limited its use of the §304 remedy to cases where the CEO or CFO was alleged to have been involved in the underlying misconduct.  In two speeches last year, Commissioner Luis Aguilar publicly criticized this previous delay in using §304 as an enforcement tool and encouraged its current and future utilization.  Many hoped the ultimate outcome of the Jenkins case would clarify the agency’s position on no-fault clawbacks and resolve some of the uncertainty.

This latest Jenkins settlement does not provide a clear answer from the agency but does suggest that a compromise may have been reached — the SEC will continue to bring no-fault clawback cases under §304, but also will approve settlements with executives for less than the full amounts at issue.  Coming on the heels of a new commissioner being appointed, this settlement gives companies some precedent with which to work.  Yet, like many compromises, this arrangement has the unsatisfying disadvantage of leaving important questions in policy limbo.  Companies, including their inside and outside legal advisors, remain unsure of how the SEC will decide whether to pursue a §304 no-fault clawback.  Further, executives wishing to at least predict their potential exposure under §304 have little guidance on how a settlement amount with the SEC might be calculated.  Unfortunately for CEOs and CFOs, if the SEC continues to refrain from adopting a clear policy position on the no-fault clawback issue, those questions will remain unanswered until future §304 actions are commenced.

(Robin M. Bergen and Shawn J. Chen are partners at Cleary Gottlieb Steen & Hamilton in Washington, D.C.)