Government Defends First Use of Sarbanes-Oxley Act's 'Clawback'

The government has told a federal judge in Phoenix that it is not misusing its "clawback" power to recoup $4 million in bonuses from the ex-CEO of CSK Auto Corp. even though prosecutors admit he was innocent of accounting fraud.

The Securities and Exchange Commission made the argument in opposition to Maynard Jenkins' motion to dismiss the disgorgement action that the agency brought against him in the U.S. District Court for the District of Arizona.

This is the first time the SEC has relied solely on a provision in the Sarbanes-Oxley Act of 2002 to "claw back" bonuses and other compensation awarded during a period in which the company's profits were boosted because of improper accounting.

Congress adopted Sarbanes-Oxley as part of a sweeping reform of securities and corporate governance regulation prompted by the massive accounting frauds that destroyed Wall Street titans such as Enron and WorldCom at the turn of the century.

The SEC maintains that it can rely solely on Section 304 of the law to recover compensation from an officer without having to prove that he personally committed securities fraud or other wrongdoing.

The agency said Section 304 requires company officials to proactively reimburse their firms for undeserved gains any time the corporation is forced to restate its financial reports because of accounting irregularities, even if there is no proof that those officers were involved or that the extra compensation was related to the overstatement.

Over the course of a year CSK was forced to restate fiscal results for 2002 through 2004 "not once, but twice, as a result of CSK's fraudulent conduct," the suit says.

During Jenkins' decade-long tenure as CSK's chairman and CEO, the company was embroiled in "a pervasive accounting fraud that involved many of its most senior officers," the complaint says.

However, in a memo in support of his motion to dismiss the suit, Jenkins argues that Congress intended Section 304 to be a clawback tool only where officers or directors got extra compensation as a result of taking part in inflating the firm's stock price.

Jenkins says the law was not intended to be used when the officer had no part in the wrongdoing or where there is no proof that the compensation was awarded because of the inflated financial reports.

"To seek this harsh penalty against someone admittedly innocent, the SEC is attempting to force a novel 'vicarious strict liability' interpretation of Section 304," Jenkins argues. "This truculent construction ... is not only unprecedented, it departs starkly from the SEC's own repeated interpretation and application of the statute since its enactment."

The SEC does not even contend that Jenkins was negligent in failing to uncover the fraud, the memo says.

"That is not what Section 304 says, not what the legislative history indicates Congress intended and not what the Constitution permits," Jenkins argues.

In its memo in opposition to dismissal, the SEC counters that Jenkins admits that the agency's suit satisfies the requirements for a Section 304 action but attempts to hide behind the Constitution's due-process clause.

It is not necessary to prove that the officer was personally involved in the alleged wrongdoing or that the stock price inflation resulted in the extra compensation, the SEC says.

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The agency is represented by SEC Regional Director Rosalind Tyson, Associate Director Michele Layne, Regional Trial Counsel John McCoy III and SEC attorneys Robert Conrad, Donald Searles in Los Angeles.Jenkins is represented by Gregory Weingart, Jenny Jiang, John Speigel and Melinda LeMoine of Munger Tolles & Olson in Los Angeles.