A recent litigation release reveals the SEC’s continued determination to use Section 304 of the Sarbanes-Oxley Act of 2002 to compel CEOs and CFOs of companies required to restate their financial statements to repay bonuses and other forms of compensation.  The SEC has sought to force the return of such executive compensation without alleging and proving fraud or other misconduct by the CEOs or CFOs.

Diebold, Inc., a manufacturer and seller of ATMs, bank security systems, and electronic voting machines, was required to restate its financial statements for 2003 and additional reporting years after allegedly engaging in accounting fraud and other misconduct (pdf).  Under Section 304, once an issuer is required to restate its financials due to material misstatements or omissions, the CEO and CFO of the issuer must reimburse the issuer for any bonus or other incentive-based or equity-based compensation received during the 12-month period following the issuance of the financial document (and the profits realized from the sale of securities of the issuer during the same 12-month period). 

The SEC alleged that former CEO Walden O’Dell violated Section 304 after failing to reimburse Diebold (pdf) for the $470,016 in cash bonuses, 30,000 shares of Diebold stock, and stock options for an additional 85,000 shares of stock he received during the 12-month period following the restated Form 10-K for 2003.  Based on the fact that O’Dell was the CEO of Diebold during the restatement period, and without any allegation of personal misconduct on the part of O’Dell, the SEC determined that a violation of Section 304 of SOX occurred and that O’Dell was responsible for reimbursing Diebold.  According to the SEC’s website, O’Dell, without admitting or denying the allegations, agreed to consent to an order requiring that he reimburse Diebold for his bonus and other incentive/equity-based compensation.

The SEC’s confidence in using the SOX “clawback” against CEOs and CFOs without any proof of fraud or other misconduct has been bolstered by two recent judicial opinions.  First, on June 9, 2010, in SEC v. Jenkins, a federal district court in Arizona ruled in favor of the SEC to allow the recovery of compensation from CEOs and CFOs without showing incidents of misconduct or fraud.  Second, on June 28, 2009, in Free Enterprise Fund v. Public Company Accounting Oversight Board (pdf), the Supreme Court upheld SOX as “fully operative as law.”  With these recent successes, we can only foresee additional use of the clawback provision by the SEC.