NEW YORK (AFX) - Sweeping corporate-reform legislation four years ago introduced the possibility of reclaiming bonuses from top executives when reported income is wiped out by later financial restatements. However, that option, known as 'clawback,' hasn't left a scratch.
In part, that's because the Securities and Exchange Commission hasn't felt compelled, for many reasons, to include the provision -- Section 304 -- in its arsenal of punishments, and the courts have thus far blocked shareholder plaintiffs from recouping bonuses in private lawsuits.
One of the highest hurdles to date, experts say, is that there is a good chance the clawback clause doesn't apply retroactively. Many of the biggest accounting flameouts of recent years -- though they may have surfaced after the July 2002 passage of the act -- related to shenanigans that took place earlier.
'I think when (the clawback provision) was passed, it created a lot of anxiety that it could be applied very broadly,' said Andrew Genser, a partner in the New York office of Kirkland & Ellis LLP and a member of the litigation practice group. 'At least at this stage of the game, it's more bark than bite. It didn't really change the legal landscape at all.'
Just ask Sanjay Kumar, CA Inc.'s former chief executive who notoriously helped send the company into an accounting tailspin, or the more obscure Dennis L. Pelino, former CEO of restatement-plagued Stonepath Group Inc.
A smattering of companies have either begun voluntarily writing their own in-house clawback policies in the event of a future restatement or, like Nortel Networks Corp., have taken steps to recoup bonuses based on revenue that later vaporized.
But with thousands of companies restating millions of dollars in earnings since the Sarbanes-Oxley act was passed in July 2002 and little effort to reclaim bonuses, activists are fuming with frustration.
Cornish Hitchcock, for one, has been pushing CA on behalf of client Amalgamated Bank since 2004, when the union-owned bank filed a shareholder resolution asking for a clawback policy. At the time, he said, CA Chairman Lewis Ranieri asked shareholders to 'be patient.'
In 2004, CA, formerly Computer Associates, avoided an indictment by reaching a deferred prosecution agreement with the U.S. Justice Department that included paying $225 million in restitution to shareholders. Kumar pleaded guilty in April to obstruction of justice and securities fraud in connection with a scheme to backdate contracts in 1999 and 2000 to falsify the Islandia, N.Y., software company's quarterly earnings reports. He is expected to be ordered to pay restitution as part of sentencing in September.
'Kumar and other top executives made a pot of money,' said Hitchcock, who has lost patience. 'It shouldn't take the grand jury, federal prosecutors, and a squad of enforcement lawyers. The board hasn't exhibited leadership on this issue.'
CA spokeswoman Jennifer Hallahan said the company is working with the government to recoup ill-gotten gains and that a special litigation committee of the board was formed to help achieve that goal. 'Our commitment has not wavered on this issue,' she said. 'We want the money returned.'
An SEC spokesman wouldn't discuss Section 304. But outside legal experts familiar with the agency's thinking point to a host of reasons the commission has likely steered clear of the issue -- including perceived problems in its drafting.
For one thing, the provision calls for the CFO and CEO to reimburse the company if an issuer has to prepare a restatement 'due to the material noncompliance of the issuer, as a result of misconduct.' It doesn't, however, pinpoint whose misconduct is at issue. Plus, years can pass before the SEC or anyone else can prove misconduct. Furthermore, the SEC likes to use its own powers of disgorgement, which, unlike clawbacks, returns money to investors rather than to the company.
Meanwhile, shareholder lawsuits trying to force executives to return compensation tied to restated financials have gone nowhere so far. In a key ruling in a derivative lawsuit filed against Stonepath's then-CEO and other former executives amid a series of restatements, a federal judge said it is the SEC that should bring such actions.
First filed in 2004, the lawsuit accuses the company of alleged breaches of fiduciary duty and other legal violations and seeks payback of millions by Pelino, who remains chairman, and former CFO Bohn H. Crain received during restatement periods.
A company spokesman declined comment, citing a pending appeal. But back in September at the time of the suit's dismissal, Pelino said the company 'believed from the beginning that this case had no foundation and we are extremely pleased to have won our motion to dismiss.'
In his ruling throwing out the case, U.S. District Judge Stewart Dalzell in Philadelphia said Congress didn't give investors an express 'private right of action' in Section 304. In contrast, Congress made clear in other sections whether or not investors explicitly have that right, he said.
That thinking bothers Steven A. Schwartz, a partner at Chimicles & Tikellis LLP in Haverford, Pa., who is handling the litigation. Dalzell's decision has been appealed to the Third Circuit Court of Appeals and Schwartz imagines that whoever loses this next round would ask the U.S. Supreme Court to review the ruling.
'Even though there have been over 2,000 restatements since Sarbanes-Oxley was enacted, the SEC has not commenced any actions to require repayment from a corporate CEO or CFO of incentive-based compensation based on those inaccurate financial statements,' Schwartz said. 'The SEC's failure to act leads to the conclusion that proper enforcement of Sarbanes-Oxley has to be left to private litigants to require insiders to give back incentive compensation that was not earned, based on the true performance of the company.'
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