It is never good when the Securities and Exchange Commission cites a company guilty of corporate misconduct. The agency now announced that it intends to crack down on corporate wrongdoing and impose clawbacks. It will do this by reviving an incomplete regulation from the financial crisis from 15 years ago as part of the Dodd Frank Act.
The revived rule stipulates that companies with U.S. stock listings that issue incorrect financial statements due to compliance mistakes would also mean a clawback of executive compensation. In other words, the CEO or CFO would forfeit a portion of their pay, notably bonuses or other incentive-based pay, when there is misconduct by the company, even if the executive was not involved. The rationale is that executives should not benefit from the proceeds of their company’s foul play.
An underutilized option
The SEC has used Clawbacks since 2002, starting with the Enron and WorldCom scandals. Since then, clawbacks were utilized 15 times to penalize executives not directly tied to the misconduct. The reason for not using was that they appeared unfair. The federal courts seemed to agree, ruling in 2016 that the SEC did not have the broad power to utilize clawbacks of executives who were not directly accused of the wrongdoing. However, the SEC now regards them as underutilized and has opened up a comment period until the end of 2022, with many assuming that it wants to broaden the clawback powers. It’s also believed that the intended increase in clawbacks would replace private settlements over financial restatements.
Accountability at the top
While the SEC now seems poised to make clawbacks more applicable, it would also require companies to enforce them. Moreover, companies would also need to explain that any restatements are not the result of noncompliance. Overall, the takeaway here is that executives are to be held more accountable for the business operations, thus being more motivated to avoid financial misstatements.