“Clawback” Provision Snags Two: SEC Sues Execs to Recover Bonuses and Stock Profits Received During Accounting Fraud
The Securities and Exchange Commission recently announced that it has sued two former executives at ArthroCare Corp., an Austin, Texas-based surgical products manufacturer to recover bonus compensation and stock sale profits they received during an accounting fraud at the company.
According to the SEC’s complaint (which you can find here: http://sec.gov/litigation/complaints/2012/comp-pr2012-51.pdf) filed in federal court in Austin, former ArthroCare CEO Michael A. Baker and former CFO Michael Gluk are not charged with personal misconduct, but they are still required under Section 304 of the Sarbanes-Oxley Act to reimburse ArthroCare for bonuses and stock profits that they received after the company filed fraudulent financial statements during 2006, 2007, and the first quarter of 2008.
“Clawback of incentive compensation and stock sale profits as authorized under the Sarbanes-Oxley Act is yet another reason for CEOs and CFOs to be vigilant in preventing misconduct and requiring that companies comply with financial reporting obligations,” said Robert Khuzami, Director of the SEC’s Division of Enforcement.
Section 304 of the Sarbanes-Oxley Act provides for reimbursement by some senior corporate executives of certain compensation and stock sale profits received while their companies were in material non-compliance with financial reporting requirements due to misconduct. The “clawback” provision can include an individual who has not been personally charged with the underlying misconduct or alleged to have otherwise violated the federal securities laws.
The SEC brought a settled enforcement action against ArthroCare in February 2011, and in July charged former ArthroCare executives John Raffle and David Applegate with perpetrating a fraudulent scheme to overstate ArthroCare’s revenues and earnings. The Commission alleged that, between 2006 and the first quarter of 2008, Raffle and Applegate caused ArthroCare to improperly record revenue from shipments of spine products to various distributors, even though the distributors often did not need the products or have the ability to pay for them. Most of the improper transactions occurred at or near the end of quarters and were intended to enable ArthroCare to satisfy external revenue and earnings targets. As a result of these transactions, ArthroCare’s publicly reported revenue and earnings were materially misstated. The Commission further alleges that Raffle misled ArthroCare’s accountants and auditor about aspects of these transactions.
Raffle and Applegate agreed to settle the Commission’s charges, without admitting or denying the complaint’s allegations. Under the settlement, Raffle consented to a judgment permanently enjoining him from violating Section 17(a) of the Securities Act of 1933 (“Securities Act”) and 13(b)(5) of the Securities Exchange Act of 1934 (“Exchange Act”) and Rules 13b2-1, and 13b2-2 thereunder, and from aiding and abetting violations of Exchange Act Sections 10(b), 13(a), 13(b)(2)(A), and 13(b)(2)(B), and Rules 10b-5, 12b-20, 13a-1 and 13a-13 thereunder. The judgment also ordered him to pay $1,782,742.43 in disgorgement plus prejudgment interest of $329,230.44, but waived payment of all but $175,000 of this amount, and does not impose a civil penalty, based upon his sworn financial statements.
Under the settlement, Raffle and Applegate both will be barred from serving as officers or directors of public companies for five years.
P.S. And speaking of ethics… My good friend, Bill McKibben, author, blogger and raconteur, picked up on a study my firm Makovsky + Company did on the financial services industry. You can find his take on it here: http://ethics-central.blogspot.com/. For those of you who don’t know Bill, he is a specialist in corporate ethics and head of the Buffalo, NY-based firm The Great Lakes Group and can be reached thusly firstname.lastname@example.org.