DODD – FRANK: CLAWBACK

Since Sarbanes-Oxley was passed, the Commission has invoked Section 304 to seek the repayment – or clawback – of certain executive compensation. Specifically, in SEC v. Jenkins, Case No. CV-09-01510 (D. Ariz. Filed July 22, 2009), the Commission for the first time sought the repayment of certain discretionary compensation from its former CEO following a restatement of the company’s financial statements. In its complaint, the SEC acknowledged that while there had been wrong doing at the company – CSK Auto Corporation – Mr. Jenkins was not involved (discussed here). Mr. Jenkins moved to dismiss (here). His motion was denied (here). A similar action was subsequently brought against the former CEO of Diebold, Inc. (here). Walden O’Dell, the former CEO of the company, settled. SEC v. O’Dell, Civil Action No. 1:10-CV-00909 (D.D.C. Filed June 2, 2010).

Dodd-Frank incorporates the SOX Section 304 clawback approach in Section 954, now Exchange Act Section 10D, but with modifications. Under this provision, issuers are required to develop a policy which provides for:

• The disclosure of its policy on incentive-based compensation that is based on financial information which is required to be reported under the securities laws; and

• The recovery of any amount of incentive based compensation paid to any current or former executive that exceeds the amount which would have been paid under an accounting restatement in the three years prior to the date on which the company was required to prepare the restatement.

To implement this section, the SEC is required to issue regulations directing the national securities exchanges and national securities associations to prohibit the listing of any security of an issuer that does not comply with these requirements.

While Dodd-Frank Section 954 incorporates the same basic clawback approach as SOX Section 304 there are important differences:

• Coverage: Section 304 only applies to the CEO and CFO, while 954 applies to any current or former executive;

• Culpability: Neither section requires that the executive be culpable. However, Section 304 is only triggered if the restatement is “due to the material noncompliance of the issuer, as a result of misconduct . . .” Section 954 does not require misconduct.

• Amount of repayment: Section 304 requires any bonus or incentive based compensation to be repaid as well as any profits realized from the sale of securities of the issuer, while 954 only requires the repayment of the amount of incentive-based compensation (including stock options) which exceeds what would have been paid under the restatement.

• Time period: The SOX section only applies to a twelve month period while Dodd-Frank provision is concerned with a three year time period.

Finally, In Digimarc Corp. Derivative Litig., 549 F.3d 1223 (9th Cir. 2008) the court refused to imply a private right of action under SOX Section 304. While it is too early for any court to have ruled on this question regarding Dodd-Frank Section 954, the implication of a private remedy under the provision seem unlikely in view of Alexander v. Sandoval, 532 U.S. 275 (2001).

Other articles in this series have covered provisions from Dodd-Frank including those concerning rating agencies (here, here and here), SEC Enforcement (here), executive compensation (here), corporate governance (here) and SEC rule making (here).

Note: Each year Lexis recognizes the top twenty five corporate and securities blogs. This blog has been nominated for this honor. To vote please click here.

ADVISER TO FEEDER FUNDS NAMED IN FRAUD ACTION

The SEC filed a fraud action against an investment adviser to funds that suffered significant losses from investing with Ponzi scheme king Bernard Madoff and fraudster Tom Petters. In the Matter of Neal R. Greenberg, Adm. Proc. File No. 3-14033 (Sept. 7, 2010). Respondent Neal Greenberg is a registered investment adviser. He is also the controlling shareholder of Tactical Allocation Services (“TAS”) and the head portfolio manager of its subsidiary Agile Group, LLC. Agile served as investment adviser to affiliated hedge funds The Safety Fund, the Performance Fund, the Master Fund, the International Fund and the Variable Fund. The Order centers on claims that Mr. Greenberg made material misrepresentations to induce investors to purchase shares in the funds and that he breached his fiduciary duty, putting many investors in funds for which they were not suited.

Many of TAS’ clients invested in the various Agile funds. In fact, by the end of 2006 about 83% of the assets under management by TAS were invested in Agile hedge funds. Many of those investors were conservative and at or near retirement age.

Between 2006 and 2008 Mr. Greenberg is alleged to have made material misrepresentations and omissions to investors to induce them to place their money in the Agile funds. Those included:

• The funds were “immensely” diversified. In fact, in September 2008 48% of the holdings of the Safety, International and Variable Funds were invested indirectly with Tom Petters. Another 14% were invested indirectly with Bernard Madoff.

• Investors were not told that the Safety, International and Variable Funds typically placed a large proportion of investor capital in a few hedge funds.

• Representations that investments in the Safety, International and Variable Funds involved minimal risk with conservative growth and that they were suitable for retirees. In fact, the 2007 PPM for the funds stated that they had a high degree of risk, sought capital appreciation and were suitable only for investors who did not require liquidity.

Overall, the three funds had concentrated positions and significant liquidity problems which made them unsuitable investments for retirees according to the Order for Proceedings. Mr. Greenberg also made misleading disclosures regarding the fees charged and improperly paid personal expenses with fund assets. The funds also had inadequate internal procedures.

By mid-September 2008, the Safety, Variable and International Funds limited redemptions due to a lack of liquidity. Later that month, redemptions were suspended because of substantial losses. The losses resulted from investing in the fraudulent scheme of Tom Petters. By December 2008 investors learned that the three funds had more losses. This time the losses came from the fraudulent scheme of Bernard Madoff.

The Order for Proceedings alleges willful violations by Mr. Greenberg of Exchange Act Section 10(b) and Advisers Section 206(1), 206(2) and 206(4). Agile is alleged to have willfully aided and abetted and caused by Mr. Greenberg willfully violated Advisers Act Section 206(4). The case is in litigation.