Executive pay is under fire again. According to a recent district court decision in the Western District of Texas interpreting section 304 of the Sarbanes-Oxley Act of 2002,1 corporate executives could lose their bonuses and other incentive compensation if their company is required to revise its financial statements as a result of misconduct, even when the executives did nothing improper. On November 13, 2012, the court in SEC v. Baker, No. A-12-CA-285-SS, 2012, WL 5499497 (W.D. Tex. Nov. 13, 2012), agreed with the Securities and Exchange Commission's view that section 304 requires chief executive officers and chief financial officers to return bonuses and certain other compensation received in years in which the corporation restated its financials, even in the absence of misconduct by the executive. This decision and the SEC's continued, aggressive enforcement of section 304 against innocent executives raises the stakes yet again for executives who fail to detect or prevent misconduct on their watch.

Section 304 of Sarbanes-Oxley

Entitled "Forfeiture of Certain Bonuses and Profits," section 304 of Sarbanes-Oxley was intended to prevent executives from profiting from corporate misconduct.2 Section 304 empowers the SEC to force CEOs and CFOs of public companies to reimburse their company for certain compensation received in years for which the issuer undertook an accounting restatement due to the issuer's "material noncompliance" with any financial reporting requirement under the securities laws.3 Such noncompliance specifically must be the result of "misconduct," although misconduct is not defined within the statute. Under section 304, CEOs and CFOs must repay bonuses, incentive or equity-based compensation, and profits realized from the sale of the issuer's securities if such compensation was received or realized by the executive during the twelve-month period following the issuer's first noncompliant filing with the SEC.4 Any compensation that the SEC obtains from the executives pursuant to section 304 goes directly to the company, regardless of whether the company (and its shareholders) want the money back, and companies may not indemnify the executives for the amount they were forced to relinquish pursuant to section 304.-

Only the SEC may enforce section 304. Courts in several circuits have determined that section 304 does not contain an express or implied private right of action, so shareholders may not bring suit under the provision.6 In cases examining this question, courts contrasted the absence of any reference to private litigation in section 304 with the explicit authorization of such litigation in other sections of Sarbanes-Oxley. Instead, section 304 refers only to the SEC's ability to exempt persons from enforcement.7

Congress broadly empowered the SEC in section 304(b) to exempt any person from the provision, "as it deems necessary and appropriate."8 Indeed, Congress appears to have recognized that prosecutorial discretion, particularly where the company is not seeking a clawback of compensation, should accompany such a draconian provision as section 304(a). Unfortunately, the SEC has not provided any meaningful guidance to date on the factors it would consider in granting such an exemption or even the process that companies should follow to seek an exemption. And, as discussed below, the SEC does not appear to have applied section 304(a) in a consistent manner from which anyone could glean any guidance – choosing to pursue zealously the compensation of some clearly non-culpable executives while giving a pass to other, equally non-culpable executives. The result has been a hodge-podge enforcement of section 304.

SEC Enforcement Actions between 2009 and 2011

Although a decade has passed since Sarbanes-Oxley became law, the SEC has brought only a few actions under section 304. Until 2009, all of these enforcement actions had been in cases where the executives participated in the misconduct at issue.9 In those circumstances, the SEC used section 304(a) as an additional mechanism to disgorge compensation from allegedly culpable executives who participated in misconduct. It is hard to quarrel with such application.

In 2009, however, the SEC deviated from its practice of using section 304(a) as a means to disgorge the compensation of CEOs and CFOs who engaged in wrongdoing. In an unexplained and surprising volte-face, the SEC in 2009 decided to bring a stand-alone section 304(a) action against Maynard Jenkins, the former CEO of CSK Auto Corporation. In an enforcement action filed on July 22, 2009 in the U.S. District Court for the District of Arizona, the SEC sought reimbursement from Jenkins of approximately $2 million in bonuses and $2 million in security sale profits – representing all of his discretionary compensation, even compensation that was unconnected with the alleged misconduct that formed the basis for the restatement.10 At issue were restatements required to correct misstatements made by CSK as a result of accounting fraud committed by CSK's CFO, Chief Operating Officer, and other finance and accounting department employees.11

According to the SEC's complaint, during Jenkins' tenure as CEO, CSK improperly failed to write off millions of dollars of receivables they were unable to collect from vendors, among other questionable accounting practices.12 Instead of writing off the uncollected receivables as required by Generally Accepted Accounting Principles ("GAAP"), CSK attempted to hide its losses through a variety of accounting tricks.13 As a result, according to the SEC, CSK overstated its income in 2002, 2003 and 2004, by amounts ranging from $11 to $34 million.14 Although Jenkins signed CSK's financial reports all three years for which restatements were required,15 the SEC did not allege that Jenkins engaged in the misconduct, instead, stating that the CFO, COO and other employees concealed their wrongdoing from Jenkins.16

Jenkins initially refused to settle, moving to dismiss the SEC's complaint on grounds that Jenkins had committed no wrongdoing and that section 304 was unconstitutionally punitive.17 In denying Jenkins' motion to dismiss, the court ruled that the plain meaning of section 304 did not require misconduct by the executive. Although the court held that section 304's meaning was unambiguous, it found that the legislative history supported Congress's intent to punish even innocent executives for corporate wrongdoing.18 The court explained that such an interpretation of section 304 was not irrational, considering that "when a CEO either sells stock or receives a bonus in a period of financial noncompliance, the CEO may unfairly benefit from a misperception of the financial position of the issuer that results from those misstated financials, even if the CEO was unaware of the misconduct leading to misstated financials."19

The court in Jenkins also denied the defendant's motion to dismiss the SEC's complaint based on the argument that section 304 was unconstitutionally punitive. The court held that the nature of the relief requested was a factual issue that could not be resolved on a motion to dismiss.20 Although the court's refusal to rule on this point left the door open for subsequent constitutional challenges, the court expressed in dicta that section 304 likely would be constitutional even if section 304 damages were punitive.21

The court also rejected Jenkins' argument that he could not reimburse "the issuer" as required by section 304, because in mid-2008, CSK became a wholly-owned subsidiary of O'Reilly Automotive and delisted from the New York Stock Exchange. According to Jenkins, requiring him to repay a successor entity, "for which he never worked, which never paid him any money, and which never suffered any harm from CSK's restatements," would be improperly punitive. The court ruled that the issuer referenced in the statute was the issuer that undertook the restatement and that Jenkins could properly pay O'Reilly as successor entity to CSK.22

Jenkins settled with the SEC on November 16, 2011, agreeing to pay CSK $2,796,467 in damages, leaving unsolved some of the potential constitutional challenges to section 304. 23

After Jenkins, the SEC brought and settled cases against other executives who had not committed misconduct in two additional matters in 2010 and 2011. On June 2, 2010, the SEC announced a settlement with Walden O'Dell, the former CEO of Diebold, Incorporated, requiring O'Dell to reimburse Diebold for $470,000 in bonuses, 30,000 shares of Diebold stock and 85,000 in stock options.24 In its complaint against Diebold, the SEC alleged that Diebold improperly recognized revenue for products that had not yet been shipped to customers, failed to accrue certain liabilities, and improperly maintained excess reserves, among other issues.25 CEO O'Dell was not alleged to have known about the improper practices or participated in the misconduct.

In 2011, the SEC brought and settled similar actions against Beazer Homes USA CEO Ian McCarthy26 and CFO James O'Leary.27 During McCarthy and O'Leary's tenure with Beazer, the company engaged in an accounting scheme to inflate certain reserves and revenue in order to artificially boost earnings. Neither McCarthy nor O'Leary was alleged to have participated in the scheme. In their settlement with the SEC, McCarthy and O'Leary agreed to reimburse Beazer almost $6.5 and $1.5 million in cash, respectively, as well as additional sums earned through stock sale profits.

The SEC's Recent Enforcement of Section 304: SEC v. Baker (November 2012)

In SEC v. Baker, No. A-12-CA-285-SS, 2012, WL 5499497 (W.D. Tex. Nov. 13, 2012), the court denied a motion to dismiss the SEC's petition to recover compensation from former Arthrocare CEO Michael Baker and CFO Michael Gluk from years during which Arthocare restated its financials due to alleged fraud by two Arthocare employees.28 Baker and Gluk were not otherwise charged with misconduct, and there is no indication that they knew about, or engaged in, any misconduct. The court rejected or did not reach each of Baker's and Gluk's many arguments challenging the SEC's interpretation of section 304, its constitutionality, and whether the penalties assessed were in violation of the Civil Asset and Forfeiture Reform Act ("CAFRA").29

The court in Baker rejected Baker's and Gluk's argument that section 304 required a finding that Baker and Gluk had violated a specific provision of the securities laws and that the SEC's recovery should be limited to profits earned as a result of the misconduct.30 Despite determining that the plain language of the statute supported the SEC's position, the court examined the legislative history of the provision, including the policy reasons for its enactment in the wake of the accounting scandals of the early 2000s. The court also found that requiring wrongdoing by executives would render section 304 meaningless because the SEC already had the power to seek disgorgement of profits earned through wrongdoing before Sarbanes-Oxley, stating, "for [section] 304 to have any meaning beyond mere exhortatory rhetoric, the Court must give effect to the statute as written, and as argued by the SEC: reimbursement is required without any showing of wrongdoing by the CEO or CFO, and . . . reimbursement is not limited to income attributable to the wrongdoing of others."31 Reading section 304 in context with other provisions of the statute, such as section 302, which requires CEOs and CFOs to certify issuers' financial statements, the court stated that Congress clearly intended to increase CEOs and CFOs accountability throughout the statute.32

The court also rejected Baker's and Gluk's argument that section 304 established an equitable remedy similar to disgorgement, and as such, required a finding of misconduct by the defendants.33 In doing so, the court declined to follow the Ninth Circuit opinion in SEC v. Jasper, 678 F.3d 1116 (9th Cir. 2012) which held that section 304 required equitable disgorgement, finding instead that section 304 was a penalty that could be imposed regardless of fault.34

The court in Baker similarly rejected the defendants' constitutional arguments that section 304 was void for vagueness. While Baker and Gluk contended that the statutory reference to misconduct was unconstitutionally vague because it did not specify to whom the term should apply, the court wrote that the reference to issuer misconduct clearly referred to the issuer and its agents acting within the scope of their employment.35 The court held that section 304 imposed liability on Baker and Gluk, citing again section 302 certification requirements in support.36 Similarly, the court found the defendants' arguments that they lacked fair notice of the statute's meaning to be without merit.37

In dismissing Baker's and Gluk's remaining constitutional challenges, the court found that section 304 did not constitute an excessive fine and did not violate the due process clause. The court held that section 304 did not violate the Excessive Fines Clause because reimbursement was paid to the issuer, not to the government and because section 304 was at least "partly remedial in nature."38 With respect to defendants' due process challenge, the court found that it was baseless because there was a reasonable relationship between the conduct of the executives and the penalty imposed. In support, the court once again cited section 302's requirement that corporate officers sign and review SEC filings, thus supposedly ensuring their accuracy.39 Furthermore, the court held that the penalty imposed by section 304, which is limited to corporate officers' bonuses, was reasonable because Congress allowed the SEC to exempt corporate officers from the provision.40

Finally, the court dismissed defendants' argument that the SEC's claim should be barred by the Civil Asset Forfeiture Reform Act ("CAFRA"), which provides that "an innocent owner's interest in property shall not be forfeited under any civil forfeiture statute."41 The court stated that CAFRA applied only to in rem proceedings, in contrast to the in personam action set forth in section 304.42 The court explained that if CAFRA were applicable, then section 304 would be meaningless because executives who engaged in wrongdoing could be prosecuted under other provisions of Sarbanes-Oxley and the Exchange Act.43

After SEC v. Baker, the SEC Spares an Innocent CEO from Section 304

Although Baker represented a significant victory for the SEC in its enforcement of section 304, the long-term significance of the decision to the SEC remains unclear. A recent settlement gives no long-term guidance although perhaps provides a glimmer of hope for a more measured application. On December 18, 2012, the SEC brought and settled actions against TheStreet, Inc., its CFO and the co-presidents of a subsidiary. According to the SEC's complaint, the co-presidents of the subsidiary allegedly engaged in a scheme to hide the subsidiary's losses in order to meet certain performance expectations set by TheStreet when it acquired the subsidiary. As a result of this alleged fraud perpetuated by its subsidiary, TheStreet reportedly filed false financial reports in 2008, resulting in a restatement of its financials in 2010.

Among other forms of relief, the SEC sought a clawback of TheStreet's CFO's compensation under section 304. The CFO allegedly inappropriately booked revenue from the subsidiary, made false statements to investors regarding the subsidiary's performance, and allegedly failed to maintain appropriate internal controls. While this application of section 304 is not inconsistent with the SEC's prior practice of seeking Section 304 relief from wrongdoers, the SEC did not also seek a clawback from TheStreet's CEO. It is unclear why the SEC chose to abstain from action against TheSteet's innocent CEO when a restatement resulting from others' misconduct occurred during his tenure, when it previously brought actions against other innocent defendants like Baker, Gluk, and Jenkins. Perhaps the SEC realizes that bringing such draconian actions against non-culpable executives provides no real deterrent for wrongdoers and instead deters good people from accepting officer positions. Perhaps the SEC acknowledges that an aggressive application of section 304 disincentives CEOs and CFOs from scrutinizing past accounting practices, or worse, from making restatements when restatements are warranted. Perhaps the SEC recognizes that good CEOs at troubled companies should not be punished beyond the stigma of being associated with the troubled enterprise. Or, on the other hand, perhaps the SEC will succumb to public pressure in the aftermath of the financial crisis and the "Occupy" protests to clawback the seemingly excessive compensation of some executives by continuing with its inconsistent enforcement of section 304 – sparing some executives while clawing back compensation from others – all the while providing no real guidance to the public. Only time will tell.

Best Practices for Avoiding Clawback of Compensation under Section 304

While the SEC's sporadic enforcement of section 304 and failure to provide any interpretive guidance are troubling, companies can take proactive steps to reduce the possibility of clawbacks.

  • The best way to avoid section 304 liability is to ensure no misconduct occurs that would rise to the level of a restatement – often a challenging task with an uncontrollable outcome even for companies with the best controls. Nonetheless, companies and executives must continue to strive to implement strong financial controls and compliance programs to prevent and detect financial irregularities and fraud. The executives themselves should be actively involved in compliance initiatives and should set the appropriate "tone at the top" for the entire company, a point the SEC has stressed over the past decade.44 Even though such steps might not have any legal effect under the strict construction of section 304, they can be important factors in the Commission's and Enforcement Staff's overall approach toward remedies and penalties.45
  • Consider structuring executive compensation as salary or other non-incentive-based compensation. For example, if an executive has a successful year, consider increasing the following year's compensation rather than rewarding though a bonus. Only bonuses and other incentive compensation are subject to clawback under section 304, while compensation received as salary is exempt.
  • If and when a bonus is awarded, memorialize the reasons at the time for the bonus. Although the SEC has been unwilling to parse the reasons for the bonus (instead clawing back entire bonuses including for items clearly unrelated to the misstatement), memorializing the reasons may provide an avenue to avoid some or all of the clawback whenever the SEC ultimately establishes and publishes some guidance or develops a formal exemption process under Section 304(b).
  • Pay bonus compensation over a longer horizon tied to goals for the company's long-term performance. This also may be a better practice because it keeps executives invested in the company's long-term performance.

Remember that section 304 is far from a settled area of law. Despite the SEC's wins in Baker and Jenkins, case law in this area is sparse and, in some cases, conflicting. Particularly in the Ninth Circuit, where courts have ruled that section 304 is an equitable remedy, defendants may be able to argue that compensation being clawed back must be linked to the misconduct, and not to other, unrelated goals.


The SEC's approach to enforcing section 304 of Sarbanes-Oxley remains ambiguous. As evidenced by the recent decision in Baker, section 304 provides a broad avenue for the SEC to clawback bonuses and other incentive compensation from innocent CEOs and CFOs when their company restates its financials due to misconduct by others. Although section 304(b) of Sarbanes-Oxley provides the Commission with broad exemption authority, the SEC has yet to provide any real guidance to the public, and a review of the enforcement actions provides no answers. Instead, the SEC has enforced section 304 in an aggressive and often inconsistent manner. If the SEC continues to use section 304 against innocent CEOs and CFOs, the public would be well served by some guidance on its application and by a formulized exemption process under section 304(b).


1 Sarbanes-Oxley Act of 2002 § 304, 15 U.S.C. § 7243.

2 See S. REP. NO. 107–205, 2002 WL 1443523, at *23 (2002).

3 Sarbanes-Oxley Act of 2002 § 304(a).

4 Id.

5 See Cohen v. Viray, 622 F.3d 188 (2d Cir. Sept. 30, 2010).

6 See e.g. Pirelli Armstrong Tire Corp. Retiree Med. Benefits Trust ex rel. Fed. Nat'l Mortg. Ass'n v. Raines, 534 F.3d 779 (2008).

7 See Cohen, 622 F.3d at 194.

8 Sarbanes-Oxley Act of 2002 § 304(b).

9 See e.g. Cohen v. Viray, 622 F.3d 188 (2d Cir. Sept. 30, 2010) (describing action against CEO and CFO who had been criminally charged under the same facts).

10 See Complaint for Violations of Section 304 of the Sarbanes-Oxley Act of 2002, SEC v. Jenkins, Case 2:09-cv-01510- JWS (July 22, 2009).

11 Id. at 4-5.

12 Id at 2.

13 Id.

14 Id.

15 Id. at 1.

16 Third Amended Complaint, SEC v. Fraser, No. CV-09-00443-PHX-GMS, 2009 U.S. Dist. Ct. Pleadings LEXIS 32456 (D. Ariz. Sept. 30, 2009) (describing defendants' efforts to conceal accounting irregularities from CSK's Disclosure Team, Audit Committee and internal investigators).

17 SEC v. Jenkins, No. CV-09-1510-PHX-GMX, 2010 WL 2347020 (D. Ariz. June 9, 2010).

18 Id. at *2.

19 Id. at *3.

20 Id. at *4.

21 Id.

22 Id. at *7.

23 Final Judgment as to Defendant Maynard Jenkins, CV-09-01510-PHX-RJB (Nov. 16, 2011). In January 2011, CSK disclosed that it had incurred almost $2 million in legal fees associated with the Jenkins litigation.

24 See SEC v. O'Dell, 1:10-CV-00909-PLF (June 2, 2010).

25 See SEC v. Diebold, 1:10-CV-00908-PLF (June 2, 2010).

26 See SEC v. McCarthy, 1:11-CV-667-CAP (N.D. Ga. Mar. 4, 2011).

27 See SEC v. O'Leary, Civ. Action No. 1:11-cv-2901 (N.D. Ga. Aug. 30, 2011).

28 SEC v. Baker, No. A-12-CA-285-SS, 2012, WL 5499497 (W.D. Tex. Nov. 13, 2012).

29 Id. at 8.

30 Id.

31 Id. at 11.

32 Id.

33 Id. at 14.

34 Courts have disagreed as to whether the provision constitutes disgorgement or a penalty. Compare Jasper (holding that section 304 provides for disgorgement, which is an equitable remedy, not a penalty), and SEC v. Microtune, 783 F. Supp. 2d 867 (N.D. Tex. 2011) (holding that reimbursement sought under section 304 is properly construed as a penalty).

35 Id. at 17.

36 Id. at 16.

37 Id.

38 Id. at 17.

39 Id.

40 Id.

41 Id. at 18.

42 Id. at 19.

43 Id. at 20.

44 See, e.g., Stephen M. Cutler, Director of the SEC Division of Enforcement, Speech by SEC Staff: Second Annual General Counsel Roundtable: Tone at the Top: Getting it Right (December 3, 2004), available at

45 Cf. SEC Policy Statement Concerning Cooperation of Individuals in Its Investigations and Related Enforcement Actions (Jan. 19, 2010), available at; Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934 and Commission Statement on the Relationship of Cooperation to Agency Enforcement Decisions (Oct. 23, 2001), available at

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