SEC’s Strict Liability Claw Strikes Again

Oooo, the Claw

Cross-posted by Forbes.com at WLF’s contributor page

In a July 2011 Legal Pulse post, SEC to Join HHS in Effort to Drop the Claw of Strict Liability on Business Managers, we decried the federal punishment of business executives based solely on their status, rather than on whether they actually violated the law. Such status crimes, we argued, do nothing to deter law breaking and by punishing blameless people, cheapen the concept of punishment.

The Securities and Exchange Commission has once again dropped “the claw” on a business manager who broke no law. SEC deployed its authority under § 304 of the Sarbanes-Oxley Act to “claw back” a $450,000 bonus from a medical product company’s former CEO, Brian Moore. Mr. Moore received the bonus during a time when four company finance executives were fraudulently misstating revenues and assets. Mr. Moore played no part in the fraud, which the finance execs actively hid from him and other senior company leaders. He was an executive at the wrong place and the wrong time. As the SEC cavalierly said in a press release about a previous clawback target, Mr. Moore was “captain of the ship and [he]profited.”

Targets of SOX § 304 clawbacks are essentially defenseless. In 2009, a former CEO, Maynard Jenkins, challenged SEC’s authority to claw back a bonus he received while employees of the company committed fraud behind his back. A federal judge in Arizona rejected his motion to dismiss, but did not directly address Jenkins’ arguments that § 304 ran afoul of the Fifth Amendment’s due process protections against excessive punitive damages, and that SEC had to show a causal relationship between the fraud and the bonus. 

Those arguments remain alive to clawback defendants, though the constitutional claim is an extreme longshot, and a judge could easily reason that § 304 contains no causation requirement. Even corporate lawyers who have written on SEC’s clawback cases have little to say on how targets can defend themselves. Their general advice is that CEOs should make sure no fraud is committed on their watch, and that companies should adopt clawback procedures of their own, so at least SEC doesn’t have to get involved.

Short of hoping Congress repeals SOX or § 304, those of us troubled by strict liability status can only plead for prosecutorial discretion. SEC can choose how and when to deploy the clawback provision. SOX does not mandate that § 304 be used in every instance where there was fraud and an executive received a bonus. The agency previously deployed this harsh provision only when executives committed a wrong and then directly profited from that wrong. Restraint and discretion are difficult concepts for federal enforcers to embrace, especially in this era of heavy competition among agencies for limited taxpayer funds. Regulators must, however, heed the advice of former U.S. Attorney General Robert Jackson:

The prosecutor has more control over life, liberty, and reputation than any other person in America. . . . [He should] select the cases for prosecution . . . in which the offense is the most flagrant, the public harm is greatest, and the proof most certain.” 

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