SEC v. Jenkins: SOX 304 Clawback Requires Innocent CEOs and CFOs to Return Incentive-Based Compensation if the Company Restates Its Financials Due to 'Misconduct'

In a case of first impression, the United States District Court for the District of Arizona recently ruled that Section 304 of the Sarbanes-Oxley Act of 2002 ("SOX"), the so-called "Clawback Provision," does not require personal misconduct by a company's CEO or CFO to trigger reimbursement obligations after an accounting restatement. Rather, a restatement caused by the misconduct of any officer, agent or employee acting within the scope of his or her employment is sufficient to require the CEO or CFO to disgorge funds under Section 304.

Section 304 of the Sarbanes-Oxley Act of 2002

SOX Section 304 provides that if an issuer "is required to prepare an accounting restatement due to material noncompliance of the issuer, as a result of misconduct, with any financial reporting requirement under the securities laws," then the CEO or CFO must reimburse the issuer for certain incentive-based compensation. This reimbursement includes any bonus or other incentive-based or equity-based compensation received during the twelve-month period following the first public filing of the financial document that is subsequently restated, as well as any profits the CEO or CFO realized from the sale of the issuer's securities during that twelve-month period. 15 U.S.C. § 7243.

Background

In SEC v. Jenkins, the Securities and Exchange Commission ("SEC") filed a complaint against Maynard Jenkins, the former CEO of CSK Auto Corp. ("CSK"), and invoked Section 304 to "claw back" more than $4 million in bonuses, incentive compensation and stock profits that he earned while CSK was allegedly committing accounting fraud.1 According to the complaint, CSK was required to prepare two accounting restatements due to its allegedly fraudulent conduct while Jenkins served as CEO. Although the complaint did not assert that Jenkins was aware of the purported misconduct, he certified the company's inaccurate financial statements during the period of the alleged fraud. SEC v. Jenkins is the SEC's first attempt to obtain Section 304 reimbursement from an individual who is not otherwise accused of violating any securities laws.2

The SEC did not allege that Jenkins was negligent in failing to uncover the fraud. Indeed, the SEC filed civil complaints against other CSK officers, alleging that those officers concealed the fraudulent scheme at issue from Jenkins.3 Jenkins moved to dismiss the SEC's complaint, arguing that he should not be liable under Section 304 because he neither...