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From Securities Regulation Daily, September 24, 2014

SEC claws back $2.5M in bonuses due to Saba fraud

By Jacquelyn Lumb and Anne Sherry, J.D.

The SEC used Sarbanes-Oxley’s clawback remedy to reach a settlement requiring a former CEO of Saba Software to repay $2.5 million in bonuses and stock profits he received after the company reported false financial results. Saba and two company vice presidents involved in the underlying time-reporting scheme also settled charges for nearly $2 million in total penalties and disgorgement.

Background. According to the charges and press release, the misstatements resulted from the falsification of time records over a period of more than four years. Professional services managers directed consultants in Saba’s Indian subsidiary to falsify time records by either recording time in advance of performance of work or failing to record time for hours worked in order to achieve their quarterly revenue and margin targets. Although the fraud was widespread throughout the organization, former vice presidents Patrick Farrell and Sajeev Menon were the most senior individuals involved and understood the impact that the scheme had on Saba’s revenue reporting.

Saba announced late in 2012 that the company is required to restate its financial statements for fiscal years 2008 through 2011 and for the first two quarters of fiscal 2012. The company has not yet filed its restatement, but expects that it will shift the timing of revenue recognition to later periods than previously reported.

Settlement with wrongdoers. Saba, Farrell, and Menon settled charges that they violated the antifraud, books-and-records, and internal-control provisions of the securities laws. Saba agreed to pay a $1.75 million civil penalty and to pay additional penalties if it has not filed earnings restatements by November 17. If the company still has not filed restatements by mid-February 2015, the registration of its securities will be revoked. Farrell and Menon each agreed to pay $50,000 in civil penalties and disgorgement and prejudgment interest of approximately $35,000 and $20,000, respectively.

Clawback. The SEC did not allege that former CEO Babak Yazdani had a part in the scheme, but the agency used Sarbanes-Oxley’s clawback provision to reach a settlement requiring him to repay the incentive compensation and trading profits he received in the year following the false reporting. Under Section 304, if an issuer is required to prepare an accounting restatement due to material noncompliance with the securities laws as a result of misconduct, the CEO must reimburse the issuer for any bonus, incentive-based compensation, or equity-based compensation he received in the 12 months following the false filings, along with any profits from the sale of securities during that 12-month period. This clawback requirement is independent of whether the CEO knew of or engaged in the misconduct.

SEC statements. During a media briefing, Enforcement Director Andrew Ceresney said the case was significant for two reasons — it highlights the importance of internal controls for companies that rely heavily on offshore operations, and it makes clear that the SEC will not hesitate to pursue clawbacks in appropriate cases. Companies that offshore critical business functions must maintain adequate internal controls over financial reporting for these functions, he advised. In addition, the clawback provisions allow the SEC to order the reimbursement of bonuses, incentive compensation, and stock sale profits even where an executive officer had no knowledge of and did not participate in the financial fraud.

In response to a question about the number of clawbacks the SEC has obtained, Ceresney said there have been cases involving 52 individuals to date, six of which involved actions in which there was no evidence that the executives had knowledge of the misconduct.

Ceresney was also asked about the conditions in which a company’s auditor may face action. He noted that Saba’s auditor, Ernst & Young, was not charged in this action. However, as a general matter, the enforcement staff always looks at the auditor’s conduct, whether it was culpable in the fraud, and whether it engaged in proper activities under GAAS.

MainStory: TopStory Enforcement FraudManipulation AccountingAuditing SarbanesOxleyAct ExecutiveCompensation DirectorsOfficers

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