SEC Requires Executives to Pay Back Bonuses Tied to Flawed Financial Reports

October 27, 2022 by Tom Ramstack
SEC Requires Executives to Pay Back Bonuses Tied to Flawed Financial Reports
U.S. Securities and Exchange Commission

WASHINGTON — The U.S. Securities and Exchange Commission on Wednesday finalized a rule that eliminates the right of corporate executives to collect bonuses if there are accounting errors in their companies’ regulatory filings.

One of the agency’s motivations is to prevent executives from profiting off quarterly reports that exaggerate their companies’ earnings.

Inflated reports to the SEC are a persistent problem that often spills over into where investors put their money in the stock market, sometimes only to be surprised when the inaccuracy is discovered and the stock value falls.

The new rule says executives must return their bonuses if the errors are found within three years after they file their financial disclosure reports and even if they are not responsible for them.

Corporate boards of directors normally tie the bonuses to their companies achieving financial targets.

The SEC rule represents an effort to comply with integrity provisions of the Dodd-Frank Act approved by Congress in 2010.

The law overhauled financial regulation in response to corporate credit abuses contributing to the Great Recession that started in 2008. The changes affected all federal financial regulatory agencies and most of the nation’s financial services industry.

The rule the SEC approved Wednesday says Congress did not intend to “punish wrongdoing, but to require executive officers to return monies that rightfully belong to the issuer and its shareholders.”

“Executive officer” is defined broadly under the rule. It includes the principal financial officer; principal accounting officer or controller; vice presidents in charge of business units, divisions or functions such as sales administration or finance; and any other officer involved in policymaking at either the parent company or a subsidiary.

Errors that initiate “clawback” requirements on bonuses could include minor errors, or “little r” mistakes, that might become major if they are left uncorrected.

SEC Commissioner Jaime Lizárraga defended the broad scope of the rule by saying corporate financial restatements “have made up an increasingly high share of all financial restatements in recent years.”

Including them in the rule ensures “executives do not have an incentive to opportunistically classify material errors,” Lizárraga said.

The nonprofit financial industry watchdog group Better Markets issued a statement praising the new rule.

“We are particularly gratified to see that it will cover a broad range of accounting restatements, not only those necessary to correct the very worst accounting abuses,” the statement said. “This rule is necessary because evidence has surfaced that some companies have been mischaracterizing their accounting restatements to avoid having to claw back their executives’ inflated and undeserved compensation.”

Republican SEC commissioners expressed misgivings that the rule might be too broad, perhaps ensnaring executives who were blameless.

Tom can be reached at [email protected] and @TomRamstack

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