Key Takeaways

• DOJ and the SEC Enforcement Division have launched initiatives targeting executive compensation clawbacks.
• The SEC is aggressively pursuing SOX 304 compensation clawbacks from Chief Executive Officers and Chief Financial Officers of public companies that have been required to restate financial reports in connection with misconduct at the company—even when the CEO and CFO are not involved and their compensation is not tied to the misconduct.
• DOJ has announced that compensation clawbacks will be considered as a factor in whether to bring and settle criminal charges against corporations. DOJ will evaluate not only whether companies have adopted clawback provisions in executive compensation packages, but also whether companies have, in practice, actually pursued clawbacks.

Background

After lurking many years in the shadows since the Sarbanes-Oxley Act of 2002 was enacted, prosecutors and regulatory officials have now trained their enforcement sights on corporate compensation clawbacks. Recent public remarks from leaders at the Department of Justice (“DOJ”) and the Securities and Exchange Commission’s (“SEC”) Enforcement Division reveal how the agencies are leveraging (and intend to continue to leverage) clawbacks in carrying out their enforcement mandates. Public companies should take heed. Here we examine the context behind these pronouncements and the planning opportunity they present for the business community.

The SEC’s Renewed Focus on Clawbacks

The SEC’s enforcement authority related to clawbacks derives from Section 304 of the Sarbanes-Oxley (“SOX 304”). SOX 304 applies where an issuer “is required to prepare an accounting restatement due to the material noncompliance of the issuer, as a result of misconduct, with any financial reporting requirement under the securities laws.”¹ In such cases, SOX 304 requires CEOs and CFOs to “reimburse” the company for (i) “any bonus or other incentive-based or equity-based compensation” paid during the 12-month period following the first public issuance of the restated financial report, and (ii) profits realized from the sale of the issuer’s securities during the same 12-month period. The SEC can pursue charges against CEOs and CFOs for violations of SOX 304 where a qualifying restatement occurs, but the executive does not reimburse the company as the statute requires.

Since its enactment 20 years ago, the SEC has pursued SOX 304 charges infrequently—typically when the SEC alleged that the covered executive had a role in the misconduct underlying the restatement. Over the past twelve months, by contrast, the SEC has settled actions or commenced proceedings for SOX 304 violations against 11 different executives. Nine have come in the last four months alone.

Several of the Commission’s recent SOX 304 cases are settled actions involving executives with zero alleged culpability. According to SEC Deputy Director of Enforcement Sanjay Wadhwa, featured at Practicing Law Institute’s annual “SEC Speaks” conference last month, the Enforcement Division views “the Commission’s use of SOX 304 orders against executives who were not charged under any additional provisions” as an “important element” of the recent SOX 304 enforcement actions, with the enforcement theory being that such actions “create[] accountability and establish[] incentives to prevent corporate wrongdoing.”²

SEC Enforcement Division Chief Counsel Sam Waldon highlighted three key aspects of how this Enforcement Division is applying SOX 304:

1. It is pursuing these cases regardless of whether the CEO and CFO at issue were culpable for the underlying securities law violation.
2. It views SOX 304 as not “limited by fraud delta,” meaning the SEC intends to seek “the full amount of the reimbursement that is required by the statute” not merely the amount by which the executive’s compensation was allegedly inflated due to the reporting problem.
3. It will seek to prevent director and officer insurance policy proceeds from being used to indemnify covered executives for SOX 304 reimbursements.

The Enforcement Division’s increased attention to SOX 304 coincides with the Commission’s June 2022 announcement that it was reopening the comment period for a new, broader clawback rule, originally proposed in 2015, to implement Section 954 of the Dodd-Frank Wall Street Reform and Consumer Protection Act.³ If adopted as proposed, that rule would require stock exchanges to establish listing standards, effectively requiring public companies to adopt policies to pursue clawbacks from executives under circumstances even broader than what is required under SOX 304.

DOJ’s New Focus on Compensation Clawbacks

Likewise, DOJ recently announced its own initiative to encourage companies to claw back executive compensation. As discussed in another OnPoint last month, when announcing revisions to DOJ policies regarding corporate criminal enforcement, Deputy Attorney General (“DAG”) Lisa Monaco highlighted individual accountability as a primary focus for DOJ. Among several policy changes, DAG Monaco announced that when evaluating corporate compliance programs for purposes of making charging and settlement decisions, DOJ will now direct prosecutors to assess whether a company’s compensation arrangements promote a culture of compliance. Part of that assessment will evaluate whether a company’s compensation program has been “crafted in a way that allows for retroactive discipline, including through the use of clawback measures, partial escrowing of compensation, or equivalent arrangements.”⁴

But it will not stop there. DAG Monaco instructed that prosecutors “will evaluate what companies say and what they do, including whether, after learning of misconduct, a company actually claws back compensation or otherwise imposes financial penalties.”⁵ She also announced that she has directed DOJ’s Criminal Division to examine ways that it can further incentivize clawback arrangements.

Shortly after DAG Monaco’s announcement, Principal Associate Deputy Attorney General (“PADAG”) Marshall Miller offered additional color regarding DOJ’s new focus on clawbacks: “[a]ll too often [DOJ] see[s] companies scramble to dust off and implement dormant policies once they are in the crosshairs of an investigation.”⁶ At that point, PADAG Miller indicated, it may be too late: “A paper policy not acted upon will not move the needle—it is really no better than having no policy at all.”⁷

DOJ’s suggested use of compensation clawbacks would be broader than SOX 304 in two significant ways: First, companies would be expected to implement and enforce clawback provisions that reach a larger swath of executives beyond just the CEO and CFO. Second, these clawbacks would not be limited to financial restatements; they could apply to any and all acts that contribute to criminal misconduct.

Key Considerations Going Forward

The recent SEC Enforcement Division and DOJ announcements provide an important opportunity for the business community to prepare. As PADAG Miller stressed, “[w]hat [DOJ] expect[s] now, in 2022, is that companies will have robust and regularly deployed clawback programs.”

All companies operating in an environment with any meaningful enforcement risk should carefully consider how their own compensation programs and executive employment agreements would fare should the company find itself under DOJ scrutiny. If adjustments are warranted, the recent clawback initiatives could afford employers helpful leverage when dealing with employees whose consent may be necessary to make the change. Separately, for companies seeking to comply with the new guidance, a thornier question may be when to pursue clawbacks. Indeed, companies often find that the cost of pursuing a clawback action can exceed the amount the company may hope to recover.

For public companies, the SEC’s recommitment to SOX 304 enforcement adds another layer of complexity in the personal financial exposure for company leaders. Particularly with an Enforcement Division taking a hard line on SOX 304’s reach, companies will want to reassess their Sarbanes-Oxley controls program to ensure that it is functioning properly, with reasonable risks being addressed in a timely fashion.

Finally, in-house legal and compliance professionals should stay tuned for further developments on clawbacks, which we expect are on the way from both agencies. The SEC’s reopened rulemaking may result in even broader clawback requirements for public companies, while the Criminal Division is expected to release new clawback-related guidance before the end of the year.

Footnotes:

1. 15 U.S.C. § 7243.
2. Sanjay Wadhwa, Deputy Director of Enforcement, Remarks at SEC Speaks (Sept. 9, 2022), https://www.sec.gov/news/speech/wadwah-remarks-sec-speaks-090922.
3. Reopening of Comment Period for Listing Standards for Recovery of Erroneously Awarded Compensation, Release No. 34-95057 (June 8, 2022); see also Listing Standards for Recovery of Erroneously Awarded Compensation, Release No. 34-75342 (July 1, 2015).
4. Lisa Monaco, Deputy Attorney General, Further Revisions to Corporate Criminal Enforcement Policies Following Discussions with Corporate Crime Advisory Group (Sept. 15, 2022), https://www.justice.gov/opa/speech/file/1535301/download.
5. Lisa Monaco, Deputy Attorney General, Remarks on Corporate Criminal Enforcement (Sept. 15, 2022), https://www.justice.gov/opa/speech/deputy-attorney-general-lisa-o-monaco-delivers-remarks-corporate-criminal-enforcement.
6. Marshall Miller, Principal Associate Deputy Attorney General, Keynote Address at Global Investigations Review (Sept. 20, 2022), https://www.justice.gov/opa/speech/principal-associate-deputy-attorney-general-marshall-miller-delivers-live-keynote-address.
7. Id.