December 11, 2007

Now That’s a Clawback: SOX Section 304 in Action

Last week, the SEC announced the largest settlement to date in an options backdating case, which included the first use by the SEC of the “clawback” provision under Section 304 of the Sarbanes-Oxley Act. The $468 million settlement was with William W. McGuire, M.D., the former Chief Executive Officer and Chairman of the Board of UnitedHealth Group. The SEC alleged that over a 12-year period, McGuire had caused UnitedHealth to grant backdated options to him and other UnitedHealth officers and employees.

Section 304 of the Sarbanes-Oxley Act provides that if an issuer is required to restate its financials as a result of misconduct, the Chief Executive Officer and Chief Financial Officer must reimburse the issuer for bonuses or other incentive-based or equity-based compensation and trading profits received or realized in the 12 months after the financial information was first publicly issued or filed with the SEC. Section 304 was enacted in response to concerns that in many instances management was benefiting from misstated financial statements resulting from some form of misconduct.

There has been some confusion as to how exactly Section 304 is to operate. The provision itself does not specify an enforcement mechanism, which caused some to wonder whether it was the SEC or the issuer (either directly or through derivative action) that is authorized to seek relief. Further, in a number of cases, private litigants have asserted that they have a private right of action to recover on behalf of the company under Section 304, which the federal courts have generally rejected. Questions have also been raised about specific language of the provision, including whether the requirement that the restatement arise “as a result of misconduct” refers to misconduct by the particular CEO or CFO against whom a Section 304 action is being brought, by the issuer generally or by others.

Under the terms of the SEC’s settlement with McGuire, he is to pay $12.7 million in disgorgement (including interest) and a $7 million civil penalty, and he will reimburse UnitedHealth for all incentive- and equity-based compensation he received from 2003 through 2006, totaling approximately $448 million in cash bonuses, profits from the exercise and sale of UnitedHealth stock and unexercised UnitedHealth options. McGuire’s disgorgement and Section 304 reimbursement will be satisfied by his return of over $600 million in cash and options to the company in resolution of employment claims and shareholder derivative suits filed against McGuire. That has got to hurt.

Now that Section 304 has been used successfully in the McGuire settlement, it is likely to be showing up in many more Enforcement cases involving restatements. I know that recovery of compensation under Section 304 is being sought in at least one other options backdating case against the former CEO and CFO of Mercury Interactive.

For more on clawback provisions generally, take a look at our “Clawback Provisions” Practice Area on

PCAOB Enforcement Ramps Up

The PCAOB announced that it settled an enforcement proceeding against Deloitte & Touche and one of its former audit partners for violations of interim auditing standards in connection with D&T’s 2003 audit of Ligand Pharmaceuticals. Under the terms of the settlement, D&T must pay a $1 million civil penalty and will undertake certain documentation practices relating to quality control policies and procedures that the firm has implemented.

As noted in this Washington Post article, “[w]hile the PCAOB has taken action against 10 accounting firms during its lifespan, yesterday’s case marks the first among the industry’s biggest players as well as the first financial penalty. Christopher M. Cutler, who has worked at the Securities and Exchange Commission and the audit board, said the Deloitte case is a milestone. ‘It shows that the PCAOB’s Enforcement Division is fully mature and also that we should expect to see within a short period of time additional cases against not only other Big Four firms, but against the so-called second four firms as well,’ Cutler said.”

FASB to Codify GAAP

Recently, the FASB announced that it plans to release its FASB Accounting Standards Codification in late 2007 or early 2008. The codification, which will be subject to a one-year comment or “verification” period, will reorganize thousands of authoritative U.S. accounting pronouncements issued by multiple standard-setters, including those of the FASB, the American Institute of Certified Public Accountants (AICPA), and the Emerging Issues Task Force (EITF) into a single source with a consistent structure. Once approved by the FASB, the codification will become the single source of authoritative U.S. GAAP, and will supersede existing FASB, AICPA, EITF and related literature. Also to be included is relevant SEC guidance.

– Dave Lynn