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Forum Report: Confusion about Sarbanes-Oxley Provision for Bonus Reimbursements

(September 7, 2004)


Sent: Tuesday, September 07, 2004 6:48 AM
Subject: Confusion about Sarbanes-Oxley provision for bonus reimbursements

The report copied below is a sidebar to a Chicago Tribune feature article, "False profits lead insiders to riches," the first in a series based on the newspaper's study of more than 200 major US companies that restated their financial results last year.
This report presents some unusually confused views of the new Sarbanes-Oxley provision for forfeiting executive bonuses.  It should be remembered that the purpose of the new provision was to make CEO and CFO reimbursements mandatory, rather than leaving it up to board discretion, whenever restatements are required as a result of misconduct.  The new law was not intended to replace the various existing means of recovering miscalculated compensation, all of which remain available if and when someone chooses to apply them.  It was also generally understood that the provision was intended to require CEO and CFO reimbursement regardless of who committed the misconduct, consistent with the Sarbanes Oxley provisions requiring CEO and CFO certifications, and it is not clear why the lawyer quoted in the article finds the act's language vague.  This is the full text of Section 304 of the Sarbanes-Oxley Act of 2002:

Section 304 -- Forfeiture of Certain Bonuses and Profits

a.       Additional Compensation Prior to Noncompliance With Commission Financial Reporting Requirements. If an issuer is required to prepare an accounting restatement due to the material noncompliance of the issuer, as a result of misconduct, with any financial reporting requirement under the securities laws, the chief executive officer and chief financial officer of the issuer shall reimburse the issuer for--

1.       any bonus or other incentive-based or equity-based compensation received by that person from the issuer during the 12-month period following the first public issuance or filing with the Commission (whichever first occurs) of the financial document embodying such financial reporting requirement; and

2.       any profits realized from the sale of securities of the issuer during that 12-month period.

b.       Commission Exemption Authority. The Commission may exempt any person from the application of subsection (a), as it deems necessary and appropriate.


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             - GL
Gary Lutin
Lutin & Company
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Money-recovery law called too hard to use

By Andrew Countryman
Tribune staff reporter

September 5, 2004

In July 2003, Dynegy Inc. owned up to some serious accounting problems.

Citing errors in accounting for complex transactions, the Houston-based energy firm wiped out $322 million in net income from 1999 through 2001 from its early 2002 report on those results.

While this was going on, however, top Dynegy executives, including then-Chief Executive Charles Watson, were taking home millions in stock profits and bonuses based in part on the inflated results.

But the company says it isn't trying to get them to give back one cent of those gains--even though there's potentially a way for it to pursue the issue.

A new federal law allows firms to try to reclaim that money from chief executives and chief financial officers in the event of "misconduct" that leads to a restatement.

Dynegy isn't alone, however. To date, experts say, no company has tapped the "clawback" law, part of the 2002 Sarbanes-Oxley corporate governance statute, to recoup executive stock and bonus gains.

It's not clear if the law even applies in Dynegy's case, in part, legal experts say, because it's so vague that it's difficult to use. In fact, some companies haven't even heard of it.

Seattle attorney William Gleeson, who has advised firms that have inquired about the law, said he thought it "would bite real hard, real quick," but it hasn't.

"We're just amazed we haven't seen more of this," he said.

Investors, however, are beginning to show signs of interest.

Shareholders at Computer Associates International Inc., which has restated earlier results, filed a resolution instructing the firm to recoup bonuses and "any other awards that were made to senior executives" on the basis of performance targets that a restatement indicates weren't actually met.

The measure did not pass, after the company said it already was reviewing those payments.

Meanwhile, shareholder suits are seeking to reclaim such money at other companies.

"Sadly, the one group that seems to have little interest in taking action to recoup ill-gotten gains from senior executives is directors," said Patrick McGurn, a corporate governance expert at the Institutional Shareholder Services proxy voting advisory firm.

One big impediment to direct action to recoup executives' money under Sarbanes-Oxley: Key terms in the law are not defined, and federal regulators haven't offered any help.

A number of head-scratchers

"The whole thing is a bit of a mystery," said Craig Roeder, partner at Baker & McKenzie law firm in Chicago. "About every third word is a term that kind of leaves you scratching your head."

The law says CEOs and CFOs shall reimburse companies for incentive-based compensation and stock sale profits received in the 12 months after the issuance of financial information that is "required" to be restated due to "misconduct."

Those are among the head-scratchers. "Misconduct" is a vague legal standard, and lawyers aren't sure if it means fraud, mere negligence or something in between. Attorneys aren't sure if it takes a civil suit from the Securities and Exchange Commission to constitute misconduct, or if such a case even guarantees meeting the misconduct standard.

"We tell them that it really is an open issue. We really don't know what `misconduct' means," Gleeson said, noting that defendants in SEC settlements typically do not admit guilt.

Experts aren't even sure what constitutes a "required" restatement. Many come about as the result of auditors' rulings, but no one's sure if that's the same as a required restatement.

Experts also aren't sure if restatements for periods before Sarbanes-Oxley took effect in 2002 qualify, even if they were filed afterward.

That's the case with Dynegy. Company spokesman David Byford said he's not aware of any efforts to recoup money under Sarbanes-Oxley.

Byford stresses the firm has made "significant progress" on improving its internal controls and financial reporting in recent years.

Meanwhile, three executives have been convicted of or pleaded guilty to charges in connection with what authorities allege was a widespread accounting fraud.

Neither ex-CEO Watson nor former CFO Robert Doty has been charged with any wrongdoing. Representatives for the two did not respond to interview requests.

In fact, in early August, Dynegy said it agreed to pay $22 million to Watson to settle a dispute over severance payments. Doty has his own severance claim scheduled for mediation in November.

Complications abound

It's unclear whether it's necessary for the CEO and CFO to have engaged in the misconduct, or if it could have occurred further down the line.

"I'd be hard put to take money away from the CEO or the CFO if it was someone else's misconduct," Gleeson said, though it could be unclear in cases where they directly supervised the person who is responsible.

A further complication: When the SEC sues individuals it accuses of engaging in financial reporting fraud, it typically seeks to recover what it calls "ill-gotten gains," which includes the same money that Sarbanes-Oxley says should be returned to the company.

SEC officials say that because the issue has not arisen, it's unclear whose claim would take precedence. But commission spokesman John Heine notes that money received in an SEC enforcement action now goes into a fund to reimburse shareholders directly.

To Gleeson, the answer is simple: No board would dare take on the feds anyway.

"My guess is you would not want to be in a position where you try to undercut the SEC," he said.


Copyright 2004, Chicago Tribune


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