Most corporate executive pay comes in the form of bonuses tied to the performance of their company. While this rewards CEOs who make their company prosper, it also gives them a perpetual temptation: Why not lie about the performance of your company so you can make even more money?
It’s a temptation some CEOs can’t resist, especially if their corporations are in dire financial straits. After the Enron and Worldcom scandals 15 years ago, Congress passed the Sarbanes-Oxley Act (SOX) which, among other things, created a “clawback” provision.
Clawbacks force CEOs to surrender any pay they received as a result of accounting fraud. After all the fraud that took place during the financial crisis, the Wall Street Reform and Consumer Protection Act – the "Dodd-Frank law" – expanded clawback provisions beyond just current CEOs to include all current and former executives, requiring clawbacks if a company’s books were restated, even if there were no evidence of criminal intent. On July 1, five years after Dodd-Frank, the Securities and Exchange Commission released its proposed rule to enforce the new clawback law.
The rule looks surprisingly tough. In the event of an accounting restatement, i.e. an admission that the numbers were wrong, whether they were fudged purposefully or not, up to three years of bonuses are fair game to be clawed back. If a corporation does not create an internal clawback policy meeting the new requirements, its stock gets delisted from all stock exchanges. Industry groups are wailing, and CEOs are supposedly considering turning bonuses back into base pay.
There’s a catch though. As Dennis Kelleher of Better Markets points out:
“Not one Wall Street firm that caused the financial crisis, almost went bankrupt and required hundreds of billions in bailouts ever restated their financial results because of that behavior. Thus, the rule proposed today may be little more than public relations unless it is substantially strengthened before it is finalized.”
While there are no apparent problems with the proposed rule, there seems to be a very big problem with the SEC’s auditors. Big Wall Street firms went through superhuman efforts to cover up their failures from their investors. One example, Lehman Brothers’ infamous “Repo 105” scandal, resulted in $50 billion in debt being wished away with fancy accounting. Despite all this fraud, the number of Wall Street accounting restatements declined during the crisis, and none of the too-big-to-fail banks ever owned up to their losses.
The sad fact is that if this provision of Dodd-Frank existed in 2008, it would likely not have made a difference. Unless the SEC cracks down on fraud, there won’t be any restatements and therefore no clawbacks. And while CEOs see that they can profit more through faked numbers than real ones. we will likely see more Worldcoms, more Enrons, and more Lehman Brothers.