SEC Warns Finance Execs: Step Up Financial Disclosure To Avoid Bonus Clawbacks

Roadmap to help finance prevent disclosure omissions

In a speech on January 25, 2016, the SEC’s Director of the Division of Enforcement, Andrew Ceresney, revealed that the SEC is targeting financial reporting deficiencies.

The SEC says they want financial executives to “recognize the immense dangers they face if they … fail to exercise due care.”

This speech is important because it includes red flags that will help finance teams strategize to prevent disclosure omissions.

Penalty for Errors Includes Clawback of Bonus & Incentive-based Compensation

The SEC is pursuing a penalty they call a “clawback.” This means they will seek penalties that mirror executive bonuses and incentive compensation as a way to financially penalize and incentivize executives to focus on enhancing accounting controls.

Top 5 Disclosure Gaps That Trigger Penalties, According to SEC

1. Revenue Recognition

• Sham transactions
• Invalid bill and holds
• Improper percentage of completion accounting
• Concealing material problems with contracts

2. Valuation and Impairment

• Failing to incorporate the risk of losses in portfolio valuation
• Improperly accounting for the declining value of the company’s assets
• Materially overstating earnings

3. Earnings Management

• Manipulating financial results to meet analyst expectations
• Falsifying data to avoid breaching a covenant

4. Missing or Insufficient Disclosures

• Omitting or understating disclosures related to executive perks and related parties, including for automobiles, apparel, meals, golf club memberships, personal tax and legal services
• Failing to disclose poor business performance

5. Internal Accounting Controls

• Deficient internal accounting controls

Audit Committee Members Are Top Disclosure Gatekeepers

• Audit committee members and external auditors are among the most important “gatekeepers” to ensure that issuers make timely, comprehensive, and accurate disclosure.
• The SEC is especially focusing on gatekeepers who approve public filings that they knew, were reckless in not knowing, or should have known were false because of other information available to them.

Red Flags To Address

According to the SEC speech, the following red flags may also be worth considering, as they suggest possible gaps that may lead to disclosure issues:

• Business growth outpacing the reporting and accounting infrastructure (this is especially relevant to startups)
• Pressure to meet earnings and performance expectations
• Focus on short term performance, rather than longer term success
• Poor oversight in units and subsidiaries
• Management’s over-reliance on processes
• Poor “tone at the top.”

Comments that Confirm The SEC Is Prioritizing Disclosure Transparency

• “Comprehensive, accurate, and reliable financial reporting is the bedrock upon which our markets are based.”
• “Audit committee members who fail to reasonably carry out their responsibilities, and auditors who unreasonably fail to comply with relevant auditing standards in their audit work, can expect to be in our focus.”
• The “SEC is openly taking an aggressive posture to ensure that companies report accurate and reliable financial information.”
• “The Commission is committed to holding accountable those whose actions prevent investors from receiving timely and reliable information that enables them to make informed investment decisions.”