Co-authored by Gregory C. Johnson

The Securities and Exchange Commission does not have to allege that the chief executive officer (CEO) or the chief financial officer (CFO) of a public company engaged in malfeasance in order for the agency to seek reimbursement to the issuer of bonuses paid to the CEO if wrongful conduct results in a restatement, an Arizona federal court ruled.

The SEC has requested a court order that would direct Maynard Jenkins, former CEO of CSK Auto Corp., to pay back about $4 million in bonuses he received when CSK’s earnings were inflated because of a purported fraud at CSK. Although there were no indications that Mr. Jenkins knew about the fraud, the SEC argued that he was still subject to the reimbursement provisions of Section 304 of the Sarbanes Oxley Act of 2002 (SOX), which provide that CEOs and CFOs must reimburse incentive pay to the issuer if a company restates its earnings because of “material noncompliance of the issuer, as a result of misconduct.”

Jenkins sought dismissal of the SEC request, contending that company officials are only subject to SOX clawback provisions if they personally engaged in wrongdoing. The U.S. District Court for the District of Arizona disagreed, holding that the plain text of the statute showed that Congress wanted to recover bonuses based on a company’s noncompliance with SOX standards, rather than on the wrongdoing of individual officers. However, the District Court narrowed its holding to the pleadings stage of litigation, explaining that defendants may be able to demonstrate that the application of the SOX clawback provisions would be overly punitive in particular circumstances and thus would run afoul of constitutional requirements. (S.E.C. v. Jenkins, 2010 WL 2347020 (D. Ariz. June 9, 2010))