The Advisors' Blog

This blog features wisdom from respected compensation consultants and lawyers

June 8, 2022

Clawbacks: Revenue Recognition Problem Leads to SOX 304 Settlement

Yesterday, in connection with charges against a software company for accounting-related misconduct that resulted in restatements of 4 years’ worth of previously filed financials, the SEC announced that the company’s founder and former CEO had agreed to reimburse the company for more than $1.3 million in stock sale profits & bonuses, as well as to return previously granted shares of company stock, pursuant to Section 304 of the Sarbanes-Oxley Act.

The SEC settled with 7 former employees for their role in the misstatements (including the longtime GC, who paid $25k in penalties). Unlike the former CFO and Controller, who are under the most scrutiny here, the CEO was not charged with misconduct. Here’s the 5-page settlement order, which summarizes the Section 304 violation as:

As a result of the conduct described above, Waldis violated Section 304 of the Sarbanes-Oxley Act of 2002, which requires the chief executive officer or chief financial officer of any issuer required to prepare an accounting restatement due to material noncompliance with the securities laws as a result of misconduct to reimburse the issuer for (1) any bonus or other incentive-based or equity-based compensation received by that person from the issuer during the 12-month period following the first public issuance or filing with the Commission of the financial document embodying such financial reporting requirement and (2) any profits realized from the sale of securities of the issuer during that 12-month period. Section 304 does not require that a chief executive officer or chief financial officer engage in misconduct to trigger the reimbursement requirement.

The order says that the restatement related to improper revenue recognition practices – including for transactions for which there was no persuasive evidence of an arrangement and prematurely recognizing software license revenue. According to the order, at least two of the revenue misstatements were facilitated through the use of “side letters or agreements” that had not initially been considered in recognizing revenue and materially changed the terms of the transactions.

Section 304 clawbacks are pretty rare, although there was one last year. Maybe we’ll see more as the Staff works through the restatements resulting from the SPAC boom. The SEC says that yesterday’s action should “put public company executives on notice that even when they are not charged with having a role in the misconduct at issue, we will still pursue clawbacks of compensation under SOX 304 to ensure they do not financially benefit from their company’s improper accounting.”

Liz Dunshee