September 18, 2009 – The enactment of the Sarbanes Oxley Act (SOX) in 2002 was the response to massive accounting fraud uncovered at a number of major U.S. corporations. One of the stated objectives of SOX was to expand the enforcement powers of the Securities and Exchange Commission (SEC) and expand accountability for corporations and their executives..
SOX Section 304 addresses the forfeiture of certain bonuses and profits paid to executives at companies that are forced to restate financials due to "material non compliance" with federal securities laws. When SOX was enacted it was unclear if the SEC would use 304 to disgorge bonuses or other performance-based compensation in the absence of fraud.
SOX 304 Enforcement in Action
The SEC sought enforcement under 304 in several options backdating cases. The most notable case, UnitedHealth Group and Chairman William McGuire, made headlines as the ultimate case for poor governance and corporate greed. Following a series of corporate financial restatements, the SEC charged McGuire from profiting on bonuses and other compensation based on falsified financial documents. The SEC’s enforcement under 304 resulted in McGuire reimbursing UnitedHealth for all incentive based equity and compensation received from 2003 to 2006 totaling close to $448M in cash. This particular case found McGuire as having violated securities laws."
More recently, the SEC evoked 304 in an enforcement action against Maynard Jenkins, the former CEO of CSK Auto. Jenkins was alleged to have profited more than $4M in bonuses and other compensation over a period of time where CSK was allegedly committing accounting fraud. This is the first action brought by the SEC seeking disgorgement under 304 from an individual who is not alleged to have otherwise violated U.S. securities laws.
Implications for Ds and Os
The SEC’s statement with the CSK/Jenkins case is alarming to corporate executives. It is clear the SEC, especially under the new administration, has honed in on the enforcement of securities laws.
Directors & Officers (D&O) Liability policies, along with indemnity agreements, are often called upon to respond to such investigations and settlements. However, restitutionary damages or disgorgement tend to be uninsurable under most states’ laws. Insurance cannot be used to pay for ill-gotten financial gain.
Particular attention must be paid to certain provisions in the D&O policy including, but not limited to, the definitions of Loss and Claim, and the affirmative treatment of how the policy will respond to a disgorgement claim. Further, severability language must be evaluated to ensure the separation of insurance interest to protect innocent directors and officers.
For more information please contact:
- John Niedernhofer, Principal
- john@barneyandbarney.com
- 858.587.7144
- Mark Doscher, Director, Executive Liability
- markd@barneyandbarney.com
- 858.587.7440
- Michele Comtois, Client Executive
- michelec@barneyandbarney.com
- 858.550.1156
