Internal Controls vs. SOX Clawbacks - The Cost of Non-Compliance!

Posted by Bill Bockwoldt on March 25, 2011

Who says SOX doesn't pay?

The SEC is pursuing more executives through Section 304, known as the "clawback" provision, to recover ill-gotten gains based on alleged fraudulent financial reporting. Recent cases include:

Beazer Homes - Former CEO and CAO charged - $6.5M recovered so far with one case still pending.

CSK Auto Corp. - Former CEO - case pending.

Diebold Inc. - Former CEO - case pending.

Navistar International - CEO and Former CFO - >$2.3M recovered.

SOX 304 mandates that corporate executives must forfeit stock sale profits & bonuses earned in the event there was a financial restatement resulting from misconduct. One interesting thing to note here is that this can happen to executives who have not even been charged with fraud, but may have benefitted from the fraudulent activity.

I believe it is hard to argue that an executive is entitled to performance-based compensation and stock awards based on over-stated earnings or unreported losses - and yet that thinking appears almost counter-intuitive when looking back at the corporate meltdowns that led to the original Sarbanes-Oxley 404 legislation.

When is it really fair to demand executive repayment based on restated financials? Only when allegations of fraud or misconduct are proven? And only if it involves the top executives? I tend to not believe the claims about not knowing the "books were cooked". If you are the people in charge, and are being compensated as such, how can that be a legitimate excuse? At the very least it is a testament to your mismanagement - and isn't that what your performance pay should be based on in the first place?

Implementing robust internal controls should prevent or at least reduce these types of activities from the outset. And when you look at the financial consequences of restatements; including the write-downs, falling stock prices, investor lawsuits, management turnover, and reduced market confidence - how can one conclude that Sarbanes-Oxley is not worth the initial cost? This is akin to regulation as insurance - to prevent the things you "don't" want to happen.

Tags: Internal Controls, SOX, 304, clawback