Staff Writer
Columbus CEO

c.2013 New York Times News Service

Financial executives who are actually held to account for misdeeds remain as rare as hen’s teeth, alas. That’s why a recent enforcement action by the Securities and Exchange Commission caught my eye.

The case was filed Dec. 4 against Fifth Third Bank, which is based in Cincinnati and has $126 billion in assets. Daniel T. Poston, the bank’s former chief financial officer, was also named in the suit.

The SEC contended that both the bank and Poston improperly delayed writing down the value of $1.5 billion of nonperforming loans in 2008. Poston certified that Fifth Third’s financial statements had been prepared in accordance with generally accepted accounting principles, but the SEC said that wasn’t the case.

Both the bank and Poston settled the case, the bank paying $6.5 million in penalties and Poston paying $100,000. Neither the bank nor Poston, who became chief strategy and administrative officer at Fifth Third in October, admitted or denied the SEC’s allegations.

The Fifth Third case is interesting because it shows that securities regulators can indeed require executives to pay penalties out of their own pockets when they settle charges of flouting securities laws.

But the regulatory action is also notable for what it did not involve: an executive pay clawback under the Sarbanes-Oxley law. Indeed, the Fifth Third action illustrates how challenging it is for regulators to mount such cases.

Sarbanes-Oxley, you’ll recall, was the legislative response to Enron, WorldCom and the other titanic accounting frauds of the early 2000s. Hoping to eliminate the temptation among executives to misstate their companies’ financial positions — making their performance look better and reaping rich bonuses as a result — the law required chief executives and chief financial officers to affirm the accuracy of their books. If misconduct resulted in an earnings restatement, those executives might have to forfeit incentive pay or proceeds from stock sales made during the 12 months after the misstatements.

That sounds relatively straightforward. But bringing such cases is complicated.

Consider the Fifth Third matter, which seems at first glance tailor-made for a clawback. The events began in August 2008, as the financial crisis was gathering force. The bank wanted to rid itself of some bad loans and arranged to sell about $1.5 billion worth the next month.

But when it came time to sell, Poston and his colleagues at Fifth Third did not write down the loans — assign them a lower value, reflecting the market’s travails — as it was required to do under accounting rules. If properly accounted for, the SEC said, Fifth Third would have recorded a $297 million loss in the third quarter of 2008. Instead, it reported a loss of less than half that size: $128 million.

Securities filings show that Poston received incentive pay — stock and option awards — of almost $350,000 the year after the misstatements, the period subject to clawbacks under Section 304 of Sarbanes-Oxley.

Poston declined to comment through a Fifth Third spokesman, who was also unwilling to discuss the settlement.

The SEC declined to discuss the Fifth Third case as well. But it probably didn’t result in a clawback because the misconduct took place during one quarter and was corrected by the time the company’s executive compensation was determined.

When Sarbanes-Oxley was passed, its executive-accountability provisions were hailed as tough medicine that could generate a flurry of recoveries.

But as the Fifth Third case illustrates, many pieces must fall into place before a case can be brought. The first requirement is a restatement of earnings, where a company goes back and adjusts previous results to reflect the accounting errors. The actions must also have been reckless or intentional. Finally, there must be recoverable executive compensation, such as a bonus received or stock sales made within one year.

“We don’t hesitate to pursue clawbacks when the law’s requirements are met,” said Andrew J. Ceresney, SEC co-director of enforcement.

Still, the hurdles limit the number of cases. Since 2007, when the SEC brought its first case, it has demanded forfeiture of compensation from executives at just 31 companies.

Of those clawback actions, 13 have come in the last three years. Executive pay has been returned in just seven of them; the rest of the cases remain in litigation or are stayed pending criminal trials.

Looking for financial-crisis cases on this roster? You won’t find many. In 2010, the SEC recovered some pay from executives at New Century Financial, a Wild West mortgage lender that collapsed in 2007. But that’s about it.

One reason for this is that rather than restating earnings when the values of securities or loans they held plummeted, many financial companies simply wrote down the assets after the collapse. They contended that their rosy valuations of the securities in previous periods were appropriate, not fraudulent.

“That might be why we didn’t see an uptick in restatements after the mortgage fiasco,” said Don Whalen, director of research at Audit Analytics, an accounting and regulatory research company in Sutton, Mass.

One of the SEC’s bigger monetary recoveries involved Beazer Homes, a large homebuilder. That matter, filed in 2011, generated almost $8 million in cash and 119,000 shares of stock from two former executives.

Since the Beazer case, though, the clawbacks have been small. In the five subsequent suits, executives have forfeited a total of about $990,000 and 160,000 stock options.

The list of cases brought by the SEC indicate that defendants fight hard and agency lawyers devote much time for potentially small sums. In 2008, for example, the agency lost a case when the court agreed with an executive’s argument that because the company had not restated its results, the SEC had been wrong to sue.

Another factor affecting the number of cases is that big, ugly earnings restatements aren’t as common as they used to be. Audit Analytics researched restatements made by 7,000 relatively large companies over the last 12 years and found that the number of companies restating results peaked in 2006, at 1,550. By last year that figure had fallen to 713.

The significance of the restatements on companies’ financials has also been dwindling. Last year, almost half of the restatements had no impact on a company’s income statement, up from 37 percent in 2007. Whalen says he thinks Sarbanes-Oxley forced companies to tighten controls over financial reporting, leading to fewer and less severe restatements.

If true, that’s good news. But consider this data point: In its 2013 fiscal year, the SEC received 557 whistle-blower tips alleging accounting abuses. If even some of those tips pan out, we’ll be expecting a jump in clawback cases.