ACFE Research Specialist
Laura Harris, CFE
Sarbanes-Oxley, my how you’ve grown.
It is hard to believe that the Sarbanes-Oxley Act of 2002 turned 20 years old in July. While some of us feel like we are in 2019 or 2020, still trying to process the way the world has been influenced by the pandemic, surely SOX wasn’t TWENTY YEARS AGO?!
Yet, here we are.
Arthur Andersen, Enron and WorldCom certainly left behind a legacy that changed the financial world, especially that of the public company. The Public Company Accounting Oversight Board (PCAOB) was born thanks to SOX and with it brought attention and improvements to:
Auditing inspections, investigations and enforcement
Corporate governance and accountability
SOX continues to evolve and help assure investors and the general public of the good faith they can place in public companies. However, as fraudsters continue to develop their own tactics, laws, measures and internal controls must always continue developing. One piece of SOX demonstrates that it is not just words on a page, but it has a deep breadth of influence and interpretability.
Section 304 of Sarbanes-Oxley
While many companies face various charges from the SEC, one of the less commonly used parts of the SOX Act includes Section 304(a) (commonly referred to as SOX 304), a provision that permits the SEC to order the disgorgement of bonuses and incentive or equity-based compensation earned by the CEO and CFO in the 12 months following the issuance of any financial statement that the issuer is required to restate because of misconduct, and the reimbursement of those funds to the issuer.
However, in 2009, while the SEC issued a settled enforcement action against CSK Auto Corp. that alleged CSK improperly accounted for vendor allowances and consequently overstated income in 2002, 2003 and 2004, the SEC also first filed to use the provision to clawback compensation in a civil suit from CSK’s former CEO who was not accused of violating any securities law. The district court sided with the SEC, concluding that SOX 304 does not contain a personal liability requirement and that it is the issuer’s misconduct that initiates the clawback provision — that is, CEOs and CFOs do not need to have personally engaged in the misconduct requiring accounting restatements to be liable for the clawback of bonuses and other incentive-based compensation under SOX 304. The court observed that disgorgement under the provision “is merited to prevent corporate officers from profiting from the proceeds of misconduct, whether it is their own misconduct or the misconduct of the companies they are paid to run.”
In 2016, the SEC declined to pursue reimbursement from the CEO and former CFO of Monsanto after the executives returned cash bonuses and stock awards received during the period of accusations. Additionally in 2016, while charging biopesticide company Marrone Bio Innovations with accounting fraud, and reaching a settlement, the SEC did not charge the company’s executives with any charges related to misconduct.
Under Section 304(b), the SEC is permitted to exempt any person as it deems necessary and appropriate. However, the SEC has not provided any meaningful guidance regarding the factors for such an exemption. As seen with Marrone Bio and Monsnato, the actions suggest that the SEC’s expectation of reimbursement of some forms of compensation, a willingness to forego an enforcement action if reimbursement is made, and a willingness to pursue an enforcement action to compel what the SEC considers appropriate or required reimbursement.
In 2021, the SEC charged the former CEO and CFO of WageWorks Inc. with making false and misleading statements and omissions — including to the company’s auditors — which resulted in the company’s improper recognition of revenue related to a contract with a large public-sector client. The SEC then invoked the rarely used SOX 304 to obtain reimbursement of incentive-based compensation earned by the executives. The SEC said that executives should not profit from their, or their company’s, misconduct.
In 2022, the SEC charged Synchronoss with accounting fraud and ordered it to pay $12.5 million in penalties. Again, the former CEO was not charged in connection with the company’s fraud but was still required to reimburse the company for over $1.3 million in stock sale profits and bonuses. Again, this demonstrated the SEC’s ability to charge all those responsible for the fraud and include the CEO, though not culpable, for being in an accountable position to prevent the fraud through implementation of stronger internal controls.
SOX 304 remains a useful, discretionary provision for the SEC. Twenty years from now, we will likely see more changes and interesting applications of all SOX provisions as fraudsters greedily continue to scam, scheme, bamboozle and hustle their way through corporations.
SOURCE: ACFE Insights – A Publication of the Association of Certified Fraud Examiners