Unless you’re a student of corporate-governance history, you probably don’t remember SOX 304. That’s OK: the SEC rarely invokes the provision. But earlier this month, the agency dusted off the measure to claw back some ill-gotten gains from the executives of a professional services firm.
As part of the Sarbanes-Oxley corporate governance reforms passed in 2002, SOX 304 addresses instances of misconduct on the part of a company’s chief executive officer or chief financial officer. If that misconduct forces a company to issue a financial restatement, SOX 304 puts the executives on the hook to reimburse the company for “any bonus or other incentive-based or equity-based compensation” received in the 12 months following the filing that triggers the restatement. The executives also have to return “any profits realized from the sale of securities of the issuer during that 12-month period.”
The SEC’s latest SOX 304 case involved charges of accounting hanky-panky by the CEO and CFO of WageWorks Inc., which provides flexible spending account services. According to the SEC, after WageWorks entered into a contract in 2016 to process benefits claims for a large public-sector client, the client told WageWorks it wouldn’t pay for certain services that WageWorks believed were included in the contract. WageWorks CEO Joseph Jackson and CFO Colm Callan directed their bean counters to recognize $3.6 million in revenue for the services anyway.
Despite repeated inquiries from the WageWorks’ accounting department and auditors about the status of the missing payment, Jackson and Callan failed to disclose the dispute, per the SEC. At one point, the pair allegedly explained to WageWorks’ auditors that the delay in receiving payment was due to an improperly formatted invoice being sent to the client. WageWorks’ executives eventually came clean about the dispute in early 2018, approximately six months after the company conducted a public stock offering.
In 2019, the company reversed the entire charge in restated financials for the second and third quarters of 2016, along with the entire fiscal year. As part of their settlements with the SEC, Jackson agreed to a clawback of roughly $2 million (which will go to WageWorks) and a $75,000 penalty, while Callan will reimburse nearly $160,000 to the company and cough up a $100,000 penalty. (HealthEquity acquired WageWorks in a $2 billion deal in 2019.)
Other notable, recent disclosure related to the SEC’s invocation of SOX 304 includes: Super Micro Computer, which in a 10-Q disclosed that its CEO was required to reimburse the sum of $2,122,000 related to a finding of irregular marketing expenses; and SAExploration Holdings, who disclosed in an 8-K that its former executive officers were required to reimburse the company for incentive-based compensation after they were accused of accounting fraud.
Notwithstanding the above examples, the SEC has been somewhat sporadic in its use of SOX 304. Cooley’s Cydney Posner offered a couple of potential explanations for this. For starters, you can’t have a SOX 304 violation without an instance of misconduct on the part of the CEO or CFO. It’s heartening to think that C-suite misconduct could be so rare as to explain the sporadic use of SOX 304. A more intriguing possibility: Financial restatements are dwindling. One study found that restatements reached a 15-year low of 83 in 2019. More often, companies are issuing “revisions” to address errors in their financial disclosures. The designation, which is reserved for immaterial errors, accounted for 383 corrections in 2019.
Given the hubbub that typically accompanies a restatement, it seems clear why companies would prefer to see their corrections deemed revisions. SOX 304 gives top executives yet another reason to avoid restatements.