Chris Prentice

WASHINGTON, (Reuters) – The U.S. Securities Watchdog’s Democratic new leadership has a message to send Corporate America’s highest-paid executives: If your company is in serious trouble, you could lose your salary.

    Clawing back compensation is shaping up to be a key part of the U.S. Securities and Exchange Commission’s (SEC) agenda as it cracks down on corporate misconduct, raising the stakes for thousands of executives who could potentially lose millions of dollars in bonuses and stock sale profits.

John Coffee from Columbia University Law School said that “clawbacks could be an important element in accountability.” “If properly implemented, they can be much more effective than they currently are.”

    Last week, the SEC said it would revive a rule left unfinished from the 2007-09 financial crisis that would require U.S.-listed companies to implement a plan to recoup executive compensation in the event they have to correct financial statements due to compliance failures.

    But in behind-the-scenes enforcement talks with companies, the SEC has already dusted off a narrower clawback power created in 2002 following the Enron and WorldCom accounting scandals, according to four lawyers familiar with the private discussions.

    That rule allows the SEC to force a public company’s chief executive or chief financial officer to return bonuses or other incentive-based pay in the event the company restates its results due to misconduct.

A federal court resolved a long-standing question about whether the SEC was allowed to recover pay paid by executives not accused of wrongdoing. Because the profits of the foul play should not be profited from, the court ruled that the agency could.

    In nearly two decades, however, the SEC has used the 2002 clawback power sparingly overall, despite potentially hundreds of opportunities to so, and just 15 times to penalize executives who were not directly accused of misconduct, according to a new analysis by law firm Covington and Burling LLP.

Gerald Hodgkins, a partner in the firm’s Washington office and a former associate director in the SEC’s enforcement division, said it was unclear why the SEC had pursued so few such actions, but that “perceived unfairness” was one potential reason.

It appears that the SEC is shifting their stance.

The enforcement personnel of the company have proposed to make use of the clawback power in private settlement negotiations for cases involving financial restates in which the CEO or CFO were not charged with misconduct. Four attorneys representing the four cases said that this is a strategy shift.

Joseph Dever, who is a Cozen-O’Connor LLP attorney and an ex-SEC enforcement lawyer, is among them.

“Staff seems to be raising this remedy far more frequently now than in the past,” he said.

After the problem with the company was solved, one of three attorneys stated that staff had suggested the restitution of executive compensation. This is highly unusual.

Three attorneys requested anonymity to discuss confidential matters.

Reuters couldn’t determine how often the SEC proposed clawbacks during settlement talks.

Allison Lee, a Democratic commissioner and senior enforcement lawyer with the agency between 2015 and 2018, said in an interview to Reuters that the 2002 power was “underutilized.”

    While Lee said she could not comment on enforcement probes over which she now has no oversight, she said of the power: “I’d like to see us ensure we are vindicating the recourse it provides for shareholders.”

ACCOUNTABILITY

Democrats believe that cracking down on corporate behavior is an important priority. They claim the SEC has been long too soft on large business.

If clawbacks are properly implemented, they can increase accountability in an age where companies view writing checks to please regulators as an expense of doing business.

Coffee said that over the last decade investors have advocated for clawback policies to help companies recover money from their missteps.

Goldman Sachs Group Inc (NYSE): For example, he failed to recover compensation from Gary Cohn, the former chief operating officer of Wall Street Banks for its involvement in Malaysia’s 1MDB sovereign funds corruption scandal. Instead, he donated the funds to charity.

Experts say that this is the reason why it’s important for regulators to use more severe clawback mechanisms.

The SEC has reopened for public comment a second clawback rule, which it originally proposed in 2015 but was not finalized. On Nov. 22, the comment period will close.

The 2010 Dodd-Frank Act requires that this rule be in place. It would capture a wider range of roles and situations for which incentives-based compensation can be recovered.

Lee acknowledged that it requires companies to implement and enforce clawbacks. However, Lee suggested it might be a powerful accountability tool.

“It’s based on the common-sense notion that you shouldn’t get to keep incentive-based comp that wasn’t actually earned,” she said in a follow-up statement. “I’m glad we’re finally moving toward implementing that mandate.”