Most of the discussion concerning SOX tends to focus on Sections 302 and 906. For example, CEOs and CFOs must now sign off on the books or face
liability. That provision comes from both Section 302 and Section 906. Section 101 created the Public Accounting Oversight Board, another commonly
discussed section of the law. However, there’s much less discussion about Section 304, which is the section I find most interesting. Section 304 creates a
penalty for failure to discover corporate misconduct by directly targeting the bonuses and incentive-based payments to CEOs and CFOs. Basically, a CEO or
CFO who fails to discover corporate misconduct may lose his or her million-dollar (and sometimes multi-million dollar) bonus. The interesting part, however,
is that under Section 304’s clawback provision, it doesn’t matter whether the executive took part in the misconduct or even whether the executive knew the
conduct was occurring; the simple failure to discover the misconduct may be enough to trigger the provision.
However, until recently, the SEC has been very slow to bring enforcement actions under Section 304. In Allison List’s article for the Ohio State Law Review
linked to below, she notes that in 2007 the SEC had brought only five actions under Section 304. Allison List, The Lax Enforcement of Section 304 of
Sarbanes-Oxley, 70 Ohio State L.J. 195 (2008).
Does this seem like a provision that should be utilized more often by the SEC? Or does this provision seem too harsh a penalty? How do you support your
response? Why might the SEC be slow in bringing actions under Section 304? SOX did not provide for a private right of enforcement under Section 304,
meaning only the SEC can bring an action; it cannot be brought by shareholders or other private injured parties. Do you think that should change? Should
shareholders of a company be allowed to bring a Section 304 against the company’s CEO when it is discovered the corporate misconduct occurred on the
CEOs watch, without him finding out about it? Does it matter whether the CEO is directly involved in the misconduct? Should it matter?
There’s an interesting case, Securities and Exchange Commission v. Michael A. Baker and Michael T. Gluk, No. A-12-CA-285-SS, 2012 WL 5499497 (W.D.
Texas Nov. 13, 2012), which, since it’s an unpublished decision and only available on Westlaw, I attached hereto for ease of reference. This case brings the
issue of Section 304 front and center. It’s a fascinating case and one I suspect will continue to be litigated. Here’s some concluding language from the court’s
decision in that case. I’m interested to hear your thoughts.
The court concluded:
“Apologists for the extraordinarily high compensation given to corporate officers have long-justified such pay by asserting CEOs take “great risks,” and so
deserve great rewards. For years, this has been a vacuous saw, because corporate law, and private measures such as wide-spread indemnification of officers
by their employers, and the provision of Directors & Officers insurance, have ensured any “risks” taken by these fearless captains of industry almost never
impact their personal finances. In enacting § 304 of Sarbanes—Oxley, Congress determined to put a modest measure of real risk back into the equation. This
was a policy decision, and while its fairness or wisdom can be debated, its legal effect cannot. Section 304 creates a powerful incentive for CEOs and CFOs
to take their corporate responsibilities very seriously indeed. The Court finds the SEC’s interpretation of § 304 is both correct and does not offend the
Constitution. Nor is CAFRA applicable. Therefore, the SEC has stated a claim for which relief can be granted.” Id. at *12.
I think the court says a lot in this one paragraph. Generally speaking, what are your thoughts about this paragraph? More specifically, is this “policy decision”
by Congress fair and wise? How would you respond to the court’s “with great risks come great rewards” discussion? Do you agree that Section 304 of SOX
simply puts “a modest measure of real risk back into the equation”?