For years, when companies overstated earnings, many executives got to keep their bonuses based on the bogus numbers. But new rules from the US Securities and Exchange Commission proposed yesterday would broaden the circumstances under which companies have to claw back unearned compensation.
Current rules require companies to take back pay from only the CEO and CFO; under a narrow set of circumstances where earnings were restated because of misconduct; and for only a year.
Under the proposed rules, clawbacks are still only required after an accounting restatement, but would extend to restatements caused by error or miscalculation, as well. They also extend the reach of clawbacks to three years.
Many companies already self-impose harsher rules than what the SEC currently requires. But they’ll surely balk at the proposed rules, which don’t offer them much discretion on when they have to pursue clawbacks. They’ll have to go after a lot more people over a much longer period of time.
The definition of “executives” covered under the proposed rule is dramatically broadener than the two positions covered now. From the rule:
The definition includes the company’s president, principal financial officer, principal accounting officer, any vice-president in charge of a principal business unit, division or function, and any other person who performs policy-making functions for the company.
The outline for the new rules was part of the Dodd-Frank financial reform bill passed in 2010, but it took until now to get the rule together. The rules passed via a closely contested 3-2 vote. The rules will be open for comment for 60 days and then face another vote.
The obvious intent of the rules is to make companies and executives more inclined to make sure they get their numbers right the first time.
“These listing standards will require executive officers to return incentive-based compensation that was not earned,” SEC commissioner Mary Jo White said in a statement. “The proposed rules would result in increased accountability and greater focus on the quality of financial reporting, which will benefit investors and the markets.”
Towers Watson adviser Steven Seelig told the Wall Street Journal (paywall) that the rule might alter compensation practices by, for example, encouraging companies to defer bonus payments in order to make them easier to claw back.
There were 831 restatements by companies on US exchanges in 2014, according to research firm Audit Analytics (pdf). However, nearly 60% of these had no impact on the filers’ income statement. The average adjustment cut income by $1.9 million.