The Securities and Exchange Commission is working to implement a controversial rule proposed in 2015 that would force companies whose financial results contain errors to claw back some of their executives’ incentive pay.
The U.S. securities regulator on Thursday said it would seek more public feedback on its existing proposal, which would put into practice a long-delayed provision required by the 2010 Dodd-Frank Act to discourage financial fraud and better align executive compensation with the accuracy of companies’ reporting.
The SEC said it was reopening the comment period in light of regulatory and market developments since 2015. “I believe we have an opportunity to strengthen the transparency and quality of corporate financial statements as well as the accountability of corporate executives to their investors,” SEC Chairman Gary Gensler said in a statement.
The proposal, which is published in the Federal Register, is subject to a 30-day comment period before the SEC potentially approves it.
Under existing rules, clawbacks are triggered only in a narrow set of circumstances involving misconduct at companies that restate earnings. A company’s board of directors typically decides whether executives should be penalized by returning some of their compensation.
The SEC’s proposal would apply to a wider range of restatements, including those that were issued because companies’ financials were later found to contain errors. It would require stock exchanges such as the New York Stock Exchange and Nasdaq to compel their listed companies to disclose and apply clawback policies. Companies that don’t comply with the rules would be delisted.
Businesses would also have to claw back incentive pay granted to both current and former executives for as many as three years before a restatement.
A split SEC, under Chairwoman Mary Jo White, in 2015 voted 3-2 to propose the rule. But the two Republican commissioners at the time criticized the proposal, saying it gave boards minimal latitude in pursuing clawbacks and that executives forced to return compensation would likely boost their salary to make up for them. The rule didn’t advance any further.
In the proposal, the SEC defines accounting restatements as the process of companies revising previously issued financials to reflect the correction of one or more errors that materially affects those statements, without describing the types of errors that would be considered material to investors.
Under that definition, the type of revision in which companies address usually minor problems, such as certain misclassifications of cash flows, by correcting the issue in their subsequent financial statements wouldn’t trigger a clawback.
These types of revisions have become increasingly common over the past decade. So-called “little r” revisions last year represented 75.7% of all restatements by U.S.-based public companies, up from 34.8% in 2005, according to data provider Audit Analytics. Major restatements, meanwhile, have become less common, comprising 24.3% of all restatements in 2020, down from 65.2% 15 years earlier, data show.
U.S.-based public companies last year filed 325 restatements, down 60% from a decade earlier, Audit Analytics said. The decline could be attributed to companies implementing better internal controls over their reporting, or because companies are avoiding major restatements to dodge clawbacks, said Derryck Coleman, director of research analytics at Audit Analytics.
The SEC, in its request for additional feedback, asked respondents to weigh in on whether the regulator’s current definition of restatements should be broadened.
The proposed rule creates the risk that executives who want to avoid a clawback would aggressively push to avoid a restatement, said Susan Schroeder, vice chair of securities and financial services at law firm Wilmer Cutler Pickering Hale and Dorr LLP.
“To the extent there are companies on the margins that want to push the envelope, this proposal would likely be an incentive for them to not issue a restatement when they otherwise might have,” said Ms. Schroeder.
The SEC is also working to implement another rule mandated by the Dodd-Frank financial overhaul that would require companies to disclose to investors how well top management’s pay tracked with corporate performance over several years, an SEC official said at a conference earlier this week.