A recently implemented SEC requirement aligned with regulatory updates could change the way your company’s accounting mistakes are scrutinized — and potentially threaten your organization’s stock exchange listing.
Intended to strengthen corporate governance and executive accountability, the SEC’s finalized ruling takes aim at excess executive compensation. The rule focuses on compensation & benefits practices, specifically seeking to curb incorrectly awarded executive bonuses by adopting incentive-based compensation clawback provisions outlined in the Dodd-Frank Act.
These clawback provisions could reshape how your organization approaches executive compensation, financial reporting, and related tax considerations. Companies may need to take immediate action, particularly as these rules intersect with technical accounting requirements, business tax considerations, and ongoing tax updates that impact compliance and reporting. Here is a breakdown of what you need to know and how to start preparing.
The SEC’s final rule, effective January 2023, requires publicly traded companies to implement policies that “claw back” bonuses paid to executives in the event of erroneously awarded compensation that is tied to misstated financial statements . Compensation must have been received by an executive officer during the three-year lookback period preceding the date an accounting statement was required.
According to the final rule, both “little r” restatements (i.e., revisions that are immaterial to prior period financial restatements) and “big R” restatements (i.e., corrections of material errors that require an organization to restate and reissue previously issued financial statements) may trigger clawbacks.
The clawback policy applies to current and former executive officers of all publicly traded companies, including emerging growth companies, controlled companies, debt issuers and other nonequity securities (with limited exceptions). The SEC defines “executive officer” to include an organization’s president, principal financial officer, principal accounting officer, any vice president who oversees a principal business unit, division or function and any other officer or individual who performs a policy-making function. Organizations are prohibited from insuring or indemnifying an executive officer against the loss of erroneously reported compensation.
The rule defines “incentive-based compensation” as “any compensation that is granted, earned or vested based wholly or in part upon the attainment of any financial reporting measure…any incentive-based compensation recovered under the final rules is compensation that an executive officer would not have been entitled to receive had the financial statements been accurately presented.” So, for example, bonuses paid from a bonus pool tied wholly or partially to financial performance would be subject to the clawback rule; salary increases and bonuses awarded based solely on employment milestones or subjective merit standards would not be.
Though the executive compensation clawback rule became effective January 27, 2023, your organization still has time to become compliant. Be sure you are aware of the following dates and deadlines:
Failure to comply with the final rule by the appropriate dates above could result in a delisting of your organization.
Ultimately, if your organization is subject to the final rule, you will need to take action in two key ways:
Begin by reviewing your organization’s current incentive programs, compensation agreements and awards. Take an inventory of all programs that award executive compensation tied to financial metrics, compare the new clawback policies to your organization’s existing policies and consider whether your policies need revisions to minimize your clawback risk amid the new executive compensation rules.
Additionally, make sure your board, executives, compliance personnel and other key stakeholders are properly educated on the final rule’s requirements and are on the same page with how performance metrics and incentive compensation may change because of the new mandates.
The Dodd-Frank Act executive compensation clawback final rule is intended to align organizations’ executive compensation more closely with actual financial performance. While this may mean that your company must rethink its incentive compensation policies, preparing for the impending policy changes and regulatory compliance ahead of the upcoming deadlines will ensure that you meet SEC guidelines — and ultimately mitigate financial risk for your organization.
Contact our financial statement audit experts to learn more about the Dodd-Frank executive compensation clawback rules or to explore other ways to take control of your business operations and your organization’s future.
