A new Securities and Exchange Commission (SEC) rule requiring the “clawback” of certain incentive compensation payments to executives should make companies want to take a close look at their internal controls and processes for preparing financial statements. That’s because if you can reduce the risk of having to file a restatement – whether for significant, material errors or even just small, seemingly inconsequential ones – it reduces the risk of executives having to pay back some or all their bonuses.
Unexpected consequences of exec comp clawback rule
In a nutshell, Rule 10D-1 requires companies to have a policy in place to recover or “claw back” certain incentive-compensation payments made to current and former executives if the company is required to file an accounting restatement. The clawback rule was included as part of the Dodd-Frank Wall Street Reform and Consumer Protection Act enacted in 2010. The SEC initially issued proposed clawback regulations in 2015 and, after several revisions, formally adopted them in October 2022.
There was some question about when a clawback would be required. It was initially thought that it might only be required in the case of a restatement for material errors (so-called Big R restatements). But in adopting Rule 10D-1, the SEC clearly stated that any restatement – Big R as well as “little r” restatements – will require executives to pay back errant incentive comp payments. This interpretation is critical because most restatements these days are for “little r” restatement; they grew from 35 percent of all restatements in 2005 to over 75 percent in 2021.
Top restatement issues of 2020
|Debt and equity securities||14.3%|
|Liabilities and accruals||12.6%|
The next step is yours
KPMG strongly advises companies to review their internal controls over financial reporting. Organizations going through a technology-enabled finance transformation are especially well-positioned to enhance their internal controls strategy organically. This can help reduce the risk of having to file a restatement, particularly over minor errors.
KPMG’s Powered Target Operating Model framework can help you accelerate the design of a solid internal controls system. Robust internal controls, in turn, can decrease the likelihood of executives having to repay some or all of their incentive compensation.
Note that even if your company voluntarily adopted an executive comp clawback policy when the SEC first issued the proposed rules in 2015 – and many companies did just that – you’ll likely need to revise the policy in light of new requirements made by the new rules. We suggest that companies immediately begin having conversations with their audit and compensation committees to ensure internal agreement on updating or adopting a clawback policy. We can also help companies prepare for or have conversations with current executives about their compensation agreements and how the new rules may impact them.